The term structure of interest rates: a comparative analysis of zero-coupon bond forward rates and Eurodollar futures rates

Abstract

Forward rates and futures rates are conceptually identical in theory. In previous studies, the term structure has been used to demonstrate that there are synchronous changes among different maturities of coupon and zero-coupon bonds. Evidence has also been found that the magnitude of these synchronous changes is inversely related to the time to maturity. This study uses the Anderson-Leies synthetic zero-coupon yield curve from Caroline Leies' study of the Term Structure a/Zero-Coupon and Coupon Bonds. The term structure of the synthetic zero-coupon bonds is used to extract the "clean" implied forward rates embedded in its yield curve to be compared to the explicit futures rates of the Eurodollar. The evidence in this study suggests that the implied forward rates of the adjusted Anderson-Leies synthetic zero-coupon yield curve are not identical to the Eurodollar Futures rates. The adjusted forward rates were found, on average, to be less than the corresponding futures rates, suggesting that a risk premium is embodied in the Eurodollar futures rates. However, the adjusted forward rates are known to possess significant measurement errors that were unable to be corrected for, but whose possible sources are noted and explained.