Group for Research in Decision Analysis

G-2015-120

The rise and fall of the squeeze propensity in the U.S. T-bond futures market - An ex-post analysis of the CME group's solution to the 5-year-gap issue

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In early 2001, the U.S. Department of the Treasury suspended the issuance of 30-year bonds, and then resumed issuing its long paper in early 2006. As a result, there is a five-year gap in the baskets deliverable into U.S. T-Bond futures contracts expiring before 2016. The CME Group recently raised the issue that grades contending for cheapest-to-deliver status are becoming significantly isolated from the rest of the basket because of this maturity gap. The aim of this paper is to provide an ex-post assessment of the approach chosen by the CME Group to address this so-called "five-year-gap issue." We first analyze the chosen solution and show that it has succeeded in substantially decreasing the anticipated problems due to the 5-year-gap issue. We then show that alternative solutions involving a reduction in the reference coupon rate would have fared better than the solution that was actually implemented by the CME Group, in both the short and the long run. We conclude that, under the prevailing environment of historic low interest rates, the real issue is not a maturity gap but rather an interest rate gap related to the conversion factor system presently experiencing its poorest performance ever, which has been exacerbated by the five-year-maturity gap in the set of deliverable bonds.

, 24 pages