On the martingale framework for futures prices. (Q2574618)

The standard risk-neutral valuation formula for a contingent claim requires a boundedness or integrability condition to be imposed either on the short interest rate process \(r_{t}\) or, equivalently, its accumulation process \(\beta _{t}=\int _{0}^{t}r_{s}\,ds\). However, the double-side boundaries on the short rate usually invoked in the literature, fail to hold for a number of widespread models of security markets. The short rate in the Ho-Lee model is one of such cases. Accordingly, arbitrage-free interest rate futures pricing needs a different regularity assumption to go through. The paper formulates this assumption as an integrability condition on the quadratic variation of the futures price process with respect to \(\beta \). As a result, it is sufficient for the accumulation process to be bounded from below only. The authors prove that the Ho-Lee interest rate process family belongs to the required category, so that interest rate futures in the corresponding market model can be priced as usual.