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The steeper the curve the more drop from contract to contract. Think of it
this way... you are a portfolio manager who can buy a security and begin
receiving interest on it at once, or you can buy a contract, take delivery
on it and not begin receiving interest until delivery. This price drop
compensates the PM for the time spent without an interest stream.
This month to month drop creates a situation in which a long always has a
slight edge (when the yield curve is steep drops of 1/2 point plus are
common). This convergence edge really creates problems for the hedger. I
haven't run the calculations in a couple of years but in the past, the drop
has always been significantly greater than the economic value. In other
words, if you hedge a portfolio with futures and don't manage the hedge, in
a quiet market, the convergence will ultimately lock in a greater loss on
the hedge side than the cash side accrues. The convergence is always
working against the short hedge.
Stewart
>Where as most commodity contracts have some positive time premium difference
>between contract months the bonds usually or always have a negitive time
>premium between contracts. Why that is, I'm not sure unless it has something
>to do with the cost of interest over time.
Stewart Taylor
Taylor Fixed Income Outlook
Voice: 501-219-9774
Fax: 501-228-0963
E-Mail: staylor@xxxxxxx
Web Site: http://www.cei.net/~staylor/
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