Price Discovery in Strategically Linked Markets

Abstract

The TED (Treasury over Eurodollar) spread between T-bill and Eurodollar futures is one relationships among interest rate contracts that is most actively watched by traders. The Eurodollar future is the more liquid market, but as the anchor of the default-free U.S. Treasury yield curve, the T-bill rate is one of the fundamental financial variables in our economy. This article looks at the behavior of the TED spread from minute to minute, to determine whether the two futures markets are cointegrated (they are) and which way information flows. While the liquid Eurodollar contract does make most of the adjustment when the spread becomes unusually wide or narrow, each market is found to transmit information to the other one, with large changes in the spread creating increased short-run correlation between them.