NEGATIVE OPTION VALUES ARE POSSIBLE - THE IMPACT OF TREASURY BOND FUTURES ON THE CASH US TREASURY MARKET

This paper uses a unique financial instrument in the U.S. Treasury mar ket to study the price behavior of the put option embedded in the Nove mber 2009-14 callable U.S. Treasury bond. We find that, beginning in A ugust 1993, the estimated option value was persistently negative on ne arly every day for the ensuing eight months. We show that the anomalou s pricing behavior arose because the underlying callable bond became t he cheapest to deliver issue against U.S. Treasury bond futures contra cts. Hence, this paper provides direct evidence that derivative assets can significantly distort pricing in the primary asset market.