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The Quality Delivery Option in Treasury Bond Futures Contracts



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    • The Fuqua School of Business, Duke University. This paper is based on my Ph.D. dissertation at the University of Chicago Graduate School of Business. I have benefited greatly from the comments of my dissertation committee: Kenneth French (chairman), George Constantinides and Robert Stambaugh (inside members); Wayne Ferson, Shmuel Kandel, and Arnold Zellner (outside members). I have received helpful comments from Douglas Breeden, William Christie, Charles Jacklin, Francis Longstaff, Merton Miller, Lance Smith, Eric Vezie, Bob Whaley, and members of the Department of Economic Analysis and Planning at the Chicago Board of Trade. I have also received valuable suggestions during workshops at the following universities: Chicago, Columbia, Duke, Indiana, Massachusetts Institute of Technology, Ohio State, Oregon, Pennsylvania, Stanford, State University of New York (Buffalo), and Washington University in St. Louis. The Chicago Board of Trade generously provided data and computer facilities used in this study. Finally, I wish to acknowledge the constructive comments of an anonymous referee and the Editor of this Journal.


This paper uses three methods to estimate quality option values for CBOT Treasury bond futures contracts. It presents evidence regarding: (1) payoffs from exercising this option at delivery, (2) estimates from a T-bond futures pricing model that incorporates this option, and (3) estimates obtained from an exchange option pricing formula. The results indicate that this option is worth considerably less than reported by Kane and Marcus (1986a). For example, payoffs obtained by switching from the bond cheapest to deliver three months prior to delivery to the one cheapest at time of delivery average less than 0.30 percentage points of par.

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