A Result and Finding to Differentiate Among Models of Term-Structure and Interest-Rate Claims

We formalize the notion of local time risk premium in the context of a theory in which the pricing kernel is a general diffusion process with spanned and unspanned components. We derive results on the expected excess return of options on bond futures. These results are organized around our new empirical finding that the average returns of out-of-the-money puts and calls, on Treasury bond futures, are negative. Our theoretical reconciliation warrants a negative local time risk premium, and our treatment refines the search for models with market incompleteness and independent sources of volatility risk.

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