Journal of Banking and Finance 5 (1981) 483-496.

North-Holland Publishing Company

FORWARD AND FUTURES PRICING OF TREASURY BILLS

George Emir MORGAN*

Unirersity of Texas, Austin, IX 78712, USA Received March 1979, final version received March 1981 The paper discusses the recent literature on interest rate futures contracts applying both traditional futures and term structure theories. It is argued that an important characteristic of futures contracts has been ignored in most of the futures literature. By constructing a riskless arbitrage between implicit forward contracts and futures contracts, it is demonstrated that even in an efficient market the futures and forward prices will be different. The difference results because the 'marking to the market' that is required on a futures contract implies that the course of interest rates is important to the pricing of interest rate futures contracts.

1. Introduction

Interest rate futures have been touted as futures contracts in the ultimate commodity, money, and indeed the rapid rise in volume and open interest have made interest rate futures contracts one of the success stories of the 70's (along with the success of options contracts). Paralleling the explosion of volume of trading in T-bill futures contracts,' there has been a substantial increase in the number of papers and articles devoted to empirical investigation of interest rate futures prices. See Poole (1978), Lang and Rasche (1978), Puglisi (1978), Vignola and Dale (1979), Chow and Brophy (1978). Ederington (1979), and Rendleman and Carabini (1979). Poole (1978) provides convincing evidence that no arbitrage opportunities exist. in the near futures contract once transaction costs are included. Lang and Rasche (1978) have examined behavior of distant contracts as well as the near contract and found substantive dilTerences between prices implied by the cash market and futures prices. Puglisi (1978) asserts that such dilTerences present opportunities for profits by hedgers. Rendleman and Carabini (1979) have found that there is no consistent divergence between T-bills and futures prices. but they do find an unusual number of circumstances where
*My appreciation is due Bob Kolb, Dick Rendleman, and Richard McEnally for their valuable comments on earlier drafts of this paper and to an anonymous referee who significantly enhanced the clarity of the presentation in the third section. I In this paper only 91 day T-bill futures will be discussed explicitly, but many of the points made apply to any interest rate futures contracts. Arthur (1971) is an excellent description of futures markets in general and Bacon and Williams (1976), Hamburger and Platt (1975), or Puglisi (1978) can be consulted for background material on T-bill futures.

0378-4266/81/0000-0000/S02.75

1981 North-Holland

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G.E. Morgan, Forward and futures pricing of treasury bills

divergences occur. There is even confusion over what instrument should be used to hedge an interest rate futures contract, for example, Ederington (1979). Fischer Black (1976) has come closest to a careful analysis of the underlying qualities of futures and forward contracts. Black carefully points out that futures contracts have no 'value' at the end of the trading day whereas forward contracts may have 'value'. The difference results from the daily resettlement process that the exchanges require of both sides to a futures contract. Unfortunately after Black recognizes this difference between forward and futures, he reverts back to the standard formulation when he assumes that the forward 'price is always equal to the current futures price' when the forward contract is initiated. This assumption is not consistent with daily resettlement. It wi11 be shown in what follows that Black (1976) and others have not adequately incorporated the effects of the daily resettlement process where profits are denominated in terms of changes in price, and therefore, futures prices cannot equal forward prices even when the forward contract is initiated and evell ill all efficient market. It is the purpose of this paper to show that observed discrepancies between forward and futures prices are not necessarily the result of inefficiencies but rather should be expected to occur in an efficient futures market. The paper presents a means of describing the way in which differences will arise and cannot be arbitraged away. The differences in prices result from the effects of the anticipated course of interest rates over the time to expiration. The course of interest rates is irrelevant to forward contract pricing but is important to buyers and sellers who must agree on a futures contract price. The paper continues 'with a section that describes forward contracts, futures contracts, and daily marking to the market. The third section demonstrates that the expected course of interest rates is as important to the pricing of futures contracts as the expected future price of T-bills on the delivery date. The fourth section is a short digression on the need for futures contracts followed by sections analyzing the theoretical price discrepancy and the effects of relaxing some assumptions. The last section is a summary. Throughout the paper, an attempt is made to synthesize the traditional futures literature and the literature on the term structure of interest rates. 2. The nature of futures contracts Some background discussion in futures and forward contracts is necessary for a full 'understanding of futures contracts because the two are very similar. In fact, some writers have considered futures contracts as a type of forward contract.f It will be shown in the next section that futures contracts can be
2For example, Sharpe (1978).

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constructed from forward contracts.' Prior to discussing pricing, this section will provide a definition of forward and futures contracts and describe the nature of futures contracts as they are currently traded on the Chicago exchanges." A forward contract is a contract whereby the seller agrees to deliver a commodity to the buyer at a specified date and price. There is no initial cash flow between the two parties at the time of agreement, and the price cannot change between date of agreement and delivery date." Forward contracts, thus, can be used to 'lock-in' the price for a transaction in the future and avoid the risk of price fluctuations. With a futures contract, the price at which delivery will actually occur is not fixed. Instead, the price changes from day to day with recontracting occurring. The purpose of this institutional structure is the next topic considered. In general, the possibility of default by either party to a forward contract is a major deterrent to forward contracting. Therefore, futures trading (which only occurs on organized exchanges) has been backed by clearinghouses of each of the exchanges that guarantee performance on contracts and match buyers and sellers at the delivery date. Futures contracts are only traded on standardized commodities, and the specific characteristics of a deliverable commodity are established by the exchanges. Telser and Higinbotham (1977) have noted that the commodities exchanges perform an insurance function and thus broaden participation in contracts relating to future delivery of a commodity. They suggest that their viewpoint is consistent with the fact that nearly all forward contracts are held to delivery date while only a small percentage of futures contracts result in delivery of the commodity. Telser and Higinbotham recognize that an integral part of the insurance function is the imposition of limits on daily price movements and a daily 'marking to the market' of all open contracts. Essentially, the mechanics of marking to the market are that the profit or loss reflected in the change in price during the day's trading must be settled at the end of the day. Profits are credited to the investor's account or losses are withdrawn. The combination of required resettlement and price limits accomplishes the goal of eliminating a large part of the exposure of the clearinghouse and the brokers." Those two features of futures contracts are the major differences

3Sharpe (1978) makes a similar argument. The question of the need for both kinds of contracts is deferred to a later section. 4The Chicago Board of Trade and The Chicago Mercantile Exchange. See Arthur (1971) or Hoel (1976) for a more detailed discussion. sThe definition is consistent with Black (1976) and Telser and Higinbotham (1977). Often 'futures contract' is defined in this manner. 6It is clear that risk is not entirely eliminated since there may be no trading at all due to price limits. Brokers may not be able to liquidate the positions of customers in default, and the broker may take a loss on the position that is not covered by the maintenance margin.

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G.E. Morgan, Forward and futures pricing of treasury bills

between forward contracts and futures contracts and may be the source of any differences in prices." Lange and Rasche (1978) recently provided evidence that a pattern of discrepancies between forward and futures prices has persisted since the initial trading of T-bill futures contracts. The discrepancies get larger as the distance of the delivery date gets farther away. Early explanations of such differences concentrated on market inefficiencies and the inexperience of market participants in the new interest rate futures market. Lang and Rasche (1978) have argued that a differential default risk is a possible source of differential pricing. While it is agreed that futures and forward contracts are different though related instruments, it is argued here that a major aspect of futures contracts - the daily resettlement based on price changes - has not been properly accounted for in any empirical research to date. More will be said in a later section regarding the default risk hypothesis.

3. T-bill futures prices relative to forward prices The traditional arbitrage" of one 91 day T-bill futures contract versus a spot T-bill9 can be used to determine the equilibrium price of a futures contract. The traditional assumptions of no market frictions or transaction costs,'? perfectly divisible securities, symmetric distributions, homogeneous beliefs, and risk neutrality!! are adopted here. The effects of relaxing some of these assumptions is addressed in a later section. Consider the choices facing an arbitrageur on the day before the futures contract's delivery date:
7Currency forward and futures markets have existed side by side, but unfortunately, the maturities have been so seldomly synchronized that observations on price differentials are difficult to obtain. Denis (1976) did find some significant differences in prices; however, he concluded that the parameters of the model are 'close' to being equal. 8Most often the arbitrage is described in terms of shorting one maturity T-bill while buying a longer maturity to create an implicit forward contract. It can be shown that the forward contract implicit in the term structure is priced the same as if it were a default free explicit forward contract. See Burger, Lang and Rasche (1977) or Bacon and Williams (1976) for a more detailed discussion of the arbitrage. 9Ederington (1979) uses the 91 day T-bill as the hedging vehicle against the futures contract when the correct vehicle must have a maturity greater than 91 days (or alternatively, should be the forward contract implicit in the term structure). lOTransactions costs on futures contracts are very small relative to the face value. For example, round trip commissions on a $1 million T-bill futures contract is $60. Initial margin is usually required as a performance bond, but a hedger can used the hedged T-bill as initial margin. To make the arbitrage opportunities equivalent, the cash used to purchase a spot contract must be used to purchase a T-bill when buying a futures contract. Thus initial margin is irrelevant to equilibrium pricing. 11 It is well known that in valuing a riskless arbitrage in complete markets that any utility function can be employed. Risk neutrality is the most convenient. Implications of risk aversion are included in the section on relaxation of assumptions.

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(a), buy a 92 day T-bill or, (b) 'buy' the futures contract to a 91 day T-bill.

The present values are determined by the 1 day spot T-biII rate. The cost of (a) is already in present dollars and must equal the present value of (b) if no arbitrage opportunities are to prevail. Thus in equilibrium:

P 92 = 1 + r~ P rut,

(1)

where superscripts denote the date (in terms of number of days before delivery) at which the price prevails, subscripts are number of days to maturity, and 'fut' denotes a futures contract for delivery of a 91 day T-biII to be delivered on day O. Eq. (1) implies that on the day prior to delivery
(2)

This is the commonly recognized relationship between futures and forward prices, but as wiII be shown below, it can be generally true only when the number of days to delivery is 1 or o. If there is more than one day to the delivery date, say D days, then the choices an arbitrageur has are basically the same but with the added obligation in a futures contract to 'mark to the market'. The choices are (a) buy a D+91 day T-biIl, or (b) 1 - 'buy' the futures contract to a 91 day T-biII thus 2 - obligating oneself to abide by the exchange's clearinghouse process of daily resettlement of futures contracts. The no-arbitrage condition now requires that the present value (as determined by the D day T-biII rate) of (a) equal the present value of (b)1 plus (b)2. Because the daily settlement process creates realized daily 'profits' or 'losses', the present value of the benefits of those cash flows over the life of the contract may be positive or negative. In equilibrium in an (otherwise) perfect market 1 1 D D P D + 9 1=1+ DPrul+l+
rD
D-I " D - I D-I rul )rD-p D LJ r D 1=1

(LiP

(3)

where L1 is the backward difference operator and r~ is the D day interest rate defined by the spot price P~ which is observed D days prior to delivery as defined earlier. The second term on the right-hand side of (3) is the interest expense or revenue that results from the daily resettlement of the futures

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G.E. Morgan, Forward and futures pricing of treasury bills

contract. The interest expense or revenue is realized at the delivery date and therefore the D day rate is employed as the discount rate in (3) similar to (1). [Note that the prices P?u;-I are not prices on futures contracts with delivery at D - t. The futures prices in the second term of (3) all refer to the same futures contract observed at the various times D - t.] If marking to the market results in the necessity to send cash to the clearinghouse, there is an interest expense of borrowing the cash until the delivery date when the loss is recouped. On the other hand, a cash inflow generates the reinvestment income of interest revenues. These additional flows may be called the 'cost of carrying' the arbitrage. Eq. (3) can be rewritten as
D-l
1= 1

pD ,,( ApD-I) rD-I PD lor= lut+ L. LJ Iut D- 1

(4 )

from which it can be seen that as long as futures prices are expected to change, futures and forward prices will not be equal. [The relationship between and .dp?u;-I is derived below in (6), but substitution of (6) in (3) and (4) only results in making the second terms in (3) and (4) appear as functions of changes in forward prices rather than futures prices.] If eq. (4) did not hold true, riskless arbitrage could be undertaken. The cash flows from rebalancing would go to finance the daily resettlement on the futures contract with any excess or deficiency loaned or borrowed until delivery date with a net profit accumulated at that time. Thus' the presumption by most researchers that futures and forward prices should be equal in an efficient market is incorrect. Futures prices must be different from forward prices as long as it is believed that there is some chance that futures prices will change through time. Eq. (4) shows that the difference between the futures price and the forward price is related to the expected changes in forward rates between agreement and delivery and related to the expected discounting rates over the time period. That is, the course of rates over time is important to the pricing of futures contracts. Eq. (4) also implies that autocorrelation will be observed in the time series of differences. Thus it is not surprising and is supportive of the analysis here that Vignola and Dale (1979) have found autocorrelation (putting aside their annualizing factor which itself induces autocorrelation) as Rendleman and Carabini (1979) also have found. Eq. (3) may be more enlightening in its dynamic form. Consider the change in the value of alternatives (a) and (b) from D+ 1 to D, where only the forward price changes. The change in value of the two alternatives must be equal if the no-arbitrage condition holds. Therefore the present value of the change in the futures price plus the change in the present value of the interest expense or revenue must equal the change in the price of a T-bill that

rg=:

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will be deliverable on the futures contract, i.e.,

-1 D AP ro r = - 1 D AP rut +D rDAP rut, 1 +rD +rD +rD

DID

DD

(5)

or
(6)

Notice that the change in value of alternative (a) is exactly the amount required for marking to the market, but because that is true, futures and forward prices cannot be equal. Otherwise the two alternatives would not have equivalent changes in value. The forward price and changes in the forward price relate to a future event (the delivery) and thus must be discounted while the daily resettlement and the change in the futures price occurs in the present. When the alternatives are viewed as an implicit forward contract versus a futures contract it can be seen with eq. (6) that a futures contract can be created with continual rebalancing of an implicit forward contract to create cash flows exactly equal to the flows from daily resettlement on a futures contract. For a hedger, then, the daily resettlement poses no hardship and in fact is a crucial part of the daily rebalancing of the hedge.P Nonetheless, futures and forward prices must differ by virtue of the daily resettlement. The insurance function of the clearinghouse has dictated the process of resettlement which is based on the denomination of profits in terms of the change in price. So the futures-forward differential is related to resettlement under the current institutional arrangement; however, resettlement based on denomination of profit and loss in terms of discounted forward prices would remove any futures-forward price differential.

4. Are futures contract needed? Given the analysis developed in the previous section and the traditional analysis, the need for the existence of futures contracts can be questioned. If futures contracts can be constructed by rebalancing forward contracts, then what does a futures market offer to an economy? First it must be realized that the arbitrage strategy outlined above may not be available to all investors. Large investors (banks, corporations, mutual funds, government securities dealers) can perform quasi-arbitrage and are more likely to incur
12The hedging and arbitrage discussed here is the discrete time analog of the continuously rebalanced Black-Scholes (1973) riskless hedge. In discrete time models recursive or enumerative methods are commonly used. See Rendleman and Bartter (1979) for an example from the options literature.

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G.E. Morgan, Forward and futures pricing of treasury bills

low transaction costs in shorting T-bills. Part of the lower transaction costs relate to the lower perceived (perhaps because of better information that is more easily obtainable) risk of default in dealing with such institutions. Thus there will be enough market participants to assure that equilibrium prices will prevail; however, not all investors can transact with low costs and good information. The existence of futures contracts offers more economic units the . opportunity to hedge cash positions than would be the case with either explicit or implicit forward contracts. The clearinghouse, as discussed above, provides insurance to investors so that there is no need to acquire information about the other side of the contract. This is particularly important for taking a short forward or futures position since there are restrictions (related to default potential in some senses) on shorting in the cash market where forward contracts are 'bundled' with spot contracts. This is a substantial problem in the commodity cash markets and is a problem of only slightly lesser magnitude in the T-bill market. These restrictions and frictions in T-bill cash markets .a nd the explicit forward market are important from the viewpoint provided by Stein (1961). Stein argues that given a utility function and beliefs about return distributions there is an optimal proportion of a portfolio that should be hedged. Factors which prevent investors from achieving the optimal hedged position (which will only be 100 percent or zero percent in unusual circumstances) result in investors holding a portfolio that is suboptimal in terms of risk of investment. The existence of forward-like contracts for which there are fewer restrictions (either economic or institutional) facilitates the attainment of the optimal portfolio allocation among risky investment opportunities in a world where there are short restrictions and forward contracts are bundled with spot contracts. The next section examines and analyzes the character of the price differential implied by the theoretical relationship shown in eq. (6).

5. Analysis of the price differential Under the unbiased expectations theory of the term structure of interest rates,'? forward prices are expectations of future prices of T-bills. The theory implies that the expected change in the forward price is zero. Because there is no expected change in future forward rates, all the terms in the summation on the right-hand side of (4) are zero, and the difference between the forward price and the futures price is zero. Under the unbiased expectations
13There is a parallel theory for 'futures' (fonvard) pricing that asserts th at price s are unbiased forecasts of future spot price s. See Fama (1976), Tewel es, Harlow and Stone (1969), and Stevenson and Bear (1970). On term structure th eorie s, see Hamburger and Platt (1975), Wood (1964), Malkiel (1966).

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hypothesis, then, forward and futures prices will be the same. That implies that tests of the equality of the implicit forward rate and the futures rate are tests of the expectations hypothesis. The evidence provided by Lang and Rasche (1978) indicates rejection of the null hypothesis of unbiased expectations since significant, consistent differences are observable. The Lang and Rasche (1978) and Puglisi (1978) analyses indicate that futures prices have been consistently lower than forward prices in most contracts. The theory developed here provides some explanations for this observed phenomenon that appear more plausible than other explanations advanced. From eq. (4), their observations are consistent with an expectation that forward prices would fall over the time period or that rates would rise over the relevant time periods. As an approximation, the Lang and Rasche difference of 60 basis points would correspond to expectations that rates would rise at a rate of 100 basis points a month. Rates did not rise that quickly, but, in fact, did rise over the periods considered. Assuming investors are rational though not infallible, the evidence is consistent with the theory developed here. Lang and Rasche (1978) found some cases where futures prices have been significantly higher than forward prices particularly in contracts nearer to delivery. The default risk explanation cannot fit comfortably with both positive and negative differentials in different contracts at the same point in time whereas the analysis presented here suggests that different portions of the timepaths of interest rates were relevant.!" That is, over a short period, rates could be expected to fall while over longer periods rates could be expected to rise. On the other hand, there is a theory of forward interest rates that suggests that forward rates incorporate not only expectations but also a liquidity premium to compensate investors for potential losses incurred in the event that the securities are liquidated prior to maturity." In other words, the expected change in the forward price is positive.!" From eq. (4), the liquidity premium theory produces futures prices that are higher than forward prices and the more distant the delivery date, the greater the difference between forwards and futures. The Lang and Rasche empirical analysis does not appear to verify the liquidity premium theory in any but the nearest-todelivery contracts since futures prices have been observed consistently below forward prices, and because using Roll's (1970) estimates of liquidity premia,
14More is said on the issue of risk premia at the end of this section. "See Malkiel (1966), Nelson (1972), Roll (1970) or Modigliani and Schiller (1973). 161n the 'futures' (forward) pricing literature this is called normal backwardation. The contango theory asserts that forward prices should be higher than expected prices and thus prices are expected to fall over time. The two theories differ in the assumption of who the hedgers in the market are. A theory of bond pricing analagous to the contango theory would be a theory that concentrates on 'income risk' instead of 'liquidity risk'. 1 am indebted to Professor Henry Latane for bringing this latter point to my attention and for suggesting that a more general theory of the term structure would include both risk factors working against one another in determining forward interest rates.

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G.E. Morgan, Forward and futures pricing of treasury bills

the magnitude of the effects would be on the order of 5 basis points which is much smaller than the observed effects; however, segmentation or preferred habitat theories may be consistent with the data since no smooth or monotone pattern of premia are presumed in those theories. In addition, the effect of expected shifts in the liquidity premium structure itself could create larger differential prices. If it were believed that the liquidity premium would increase to a peak and then drop during the period between agreement and delivery date,"? the forward price might be, on net, lower than the future price. Unfortunately, there is no method known to measure expectations regarding the time path of the liquidity premium. 6. The effect of relaxing some assumptions The qualitative effects of relaxing four assumptions can be examined to provide insight into more realistic futures pricing. The existence of a differential between rates at which gains can be reinvested and losses can be borrowed should magnify the size of the effects discussed here. An asymmetric distribution of price changes is more appealing than symmetric distributions because of the lower bound on price changes (i.e., - 100 percent) and because empirically a lognormal distribution appears to fit the data better than a normal distribution. The skewness of the distribution of price changes becomes important when there is also a borrowing-lending rate differential and wiII increase the magnification of other effects such as the movement of liquidity premia over time. Upon relaxing the assumption of risk neutrality, the issue of risk prernia'" in the futures market that are not already contained in the forward market is important for pricing. The existence of a premium cannot be justified based on traditional arguments. In the traditional literature the controversy over the existence of premia centers on different assumptions regarding who the hedgers are. Are the hedgers short hedgers or long hedgers? In the first case, speculators must be paid a risk premium to take long futures positions. In the second case, speculators must be compensated for short positions that allow the hedger to get the desired insurance. In some markets, these distinctions are not meaningful. For example, Burns (1976) points out that whether a premium or discount exists in foreign exchange futures depends on 'which side of the coin' is considered. Furthermore, as is the case in the T-biII markets, there are few restrictions on active market participants 19 creating
17This may occur in consonance with a cyclical rise in risk premia as examined in Fisher
(1959), or as the result of increased uncertainty regarding the direction of monetary policy in a

rapidly changing economic environment. Friedman (1979) also provides evidence that the size of the liquidity premia may be related to the level of interest rates. 18Dusak (1973) recently pointed out that conceptually only systematic risk is relevant to the existence of a risk premium. 19In both these markets, banks and large corporations, can .easily arbitrage the futures markets either way.

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short hedges or long hedges.i? That is, any observed price discrepancies can be captured by entering into a riskless arbitrage. The activity of market participants to capture premia while taking a riskless position will result in the premia being bid away. The differences between the traditional literature and the arguments made here are the result of the different instruments given consideration. Traditionally, two different agreements are considered: one to buy a commodity at a future date and one to buy a commodity immediately. The price in each case is different and there is reason to believe that hedgers of the spot commodity would pay an insurance premium that would systematically bias forward prices. In contrast, there appears to be little support for the contention that T-bill futures contracts are systematically biased by an insurance premium paid by hedgers of forward contracts. Although Lang and Rasche (1978) note the implausibility of a risk premium in futures markets when riskless arbitrage possibilities exist, they suggest that default risk may account for some of the differential. The default to which they refer is the default of an investor, his broker, the exchange clearinghouse, and the exchange membership on either resettlement or delivery. Although this risk could be considered entirely non-diversifiable, the event is so remote that the resulting premium could not be large enough to explain observable differences. For example, interest rate risk/horizon risk is many orders of magnitude larger than this default risk, yet it is generally believed that 50 to 100 basis points is the magnitude of the liquidity premium. Furthermore, it is not entirely clear how the default premium explanation used by Lang and Rasche (1978) necessarily implies a premium for the long side of the contract for distant contracts since the long side may also default, and as discussed earlier, the clearinghouse guarantees both sides of the contract. Similarly, it is unclear why the short side of the contract should receive a premium on near contracts. A risk premium of another sort may be justified if the assumption of homogeneous beliefs is relaxed. If an investor is unaware what other investors believe about the course of interest rates, then it may be possible for the investor to exact risk compensation because the current equilibrium price from (4) is unknown. But even that risk premium has some implausibility since there are two parties subject to that same risk on every contract. Furthermore, if in developing eq. (3) a risk adjusted discount rate were used to discount to the present net cash flows received at delivery date, no change in the ensuing equations would be required and the futuresforward differential would still be given by (4) in terms of expected changes in forward rates.
2In some cases, riskless arbitrage [or what Rendleman and Carabini (1978) call quasiarbitrage] is a more accurate description of the process.

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G.E. Morgan, For.....ard and futures pricing of treasury bills

7. Summary and conclusions A discussion of the nature and usefulness of futures contracts revealed that there are a number of differences between futures and forward contracts. A major difference, that results from the insurance role of the clearinghouse of a futures exchange, is the requirement of daily marking to the market. It was demonstrated that this difference would result in different prices for forward and futures contracts. Even in an efficient market, there will be a difference between forward and futures prices because futures prices incorporate expectations regarding the course of interest rates between agreement and delivery dates whereas forward prices do not. Empirical studies have all presumed that in efficient markets forward and futures were the same. Thus their analysis of the empirical evidence must be suspect. For example, Puglisi (1978) advises that the observed discrepancies are profit opportunities waiting to be exploited by simple riskless hedges or arbitrage strategies. Similarly, many brokerage houses tout the profit opportunities by referring to the standard formula that presumes forward and futures are the same. This is particularly troublesome given that the analysis here indicates that the 'discrepancies' call result from efficient pricing based on expectations that rates will rise over the relevant time period. Unfortunately, the analysis presented here dashes any hopes of testing term structure hypotheses a la Chow and Brophy (1978) or more generally of using futures prices as easily accessible, direct, market forecasts of future interest rates at a single future time point, Poole (1978).21 By their construction, futures prices also include data regarding market expectations of the future course of interest rates over a time period. The analysis suggests that empirical tests can provide evidence regarding the validity of some of the theories of the term structure because some of those theories imply hypotheses regarding the course of interest rates. The evidence, so far, seems to favor rejection of the expectations hypothesis.F On the other hand, it appears that it will be difficult to test the appropriateness of other term structure theories versus the liquidity premium theory since so little has been done on the movement of liquidity premia over time. That is, it appears that term structure efforts are back at the starting point. In order to test the theories, an 'independent' source of interest rate expectations is needed (and in the case of T-bill futures, expectations about movements in forward rates). T-bill futures prices are not such a source in either case, even in an efficient market, contrary to the presumptions made by Lang and Rasche (1978), Poole (1978), Chow and Brophy (1978), and Puglisi (1978).
21This has no implication for Poole's empirical work since he only considered the contract nearest to delivery where the effects analyzed here have little impact. 22Rendleman and Carabini (1979) could be used as evidence to support the acceptance of the expectations hypothesis. .

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References
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