Abstract
This article studies the profitability and arbitrage efficiency of the Chicago Mercantile Exchange (CME) Nikkei 225 futures. As one of the most typical quanto derivatives in the world, the CME Nikkei futures is traded in dollars while the underlying Nikkei index is traded in yen. The special characteristic involves more complicated uncertainties, which necessitate an investigation into its profitability and efficiency. To this end, we construct an arbitrage-free quanto pricing model to examine the mispricing of the CME Nikkei futures and the underlying spot prices for potential arbitrage opportunities. Distinguishing an ex-post trading rule from an ex-ante trading rule, we conduct non-parametric moving block bootstrap simulations to test the significance of profitability in the CME. The results show insignificant ex-post profitability but significant ex-ante profitability before and after the 2008 global financial crisis. Moreover, delayed execution significantly impacts the futures profitability. Profitable arbitrage opportunities are confirmed by implied transaction costs and explained by lagged absolute mispricing, lagged error, futures time to maturity, stock volatility, and trading volume in the CME. These findings have important implications for practitioners in their cross-border arbitrage trades, and for policy makers in their regulation of quantos in futures globalization.
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Notes
Yen-denominated Nikkei 225 futures are simultaneously listed on the Osaka Exchange and the Singapore Exchange, apart from the CME. The Singapore Exchange starts to trade dollar-denominated Nikkei 225 futures from 2006, which is not considered in this article due to the relatively short time series.
This is based on the aforementioned Nikkei dividend payment practice that most Nikkei firms pay dividends in the last two weeks of June (year-end) and the first two weeks of December (interim). We follow Qin et al. (2019) to use the assumption to derive the arbitrage-free quanto pricing model.
The reason for rescaling further by 100 in Eq. (8) is that the RM is expressed in percent of the index.
Data are obtained from the CME and Datastream.
Tu et al. (2016) report an overwhelming amount of concurrent volatility in futures mispricing during the GFC.
Transaction costs of arbitraging the CME Nikkei futures comprise brokerage commissions in the spot and futures markets, interest costs or short-selling costs in the spot market, Globex fees, clearing fees in the open outcry and Globex, market impact costs in the spot and futures markets, and currency conversion costs. These vary between investor groups and are subject to regulatory changes.
The estimation is based on the literature. For example, Białkowski and Jakubowski (2008) assume the transaction costs to be 0.3%, 0.6% and 0.9% in the Polish WIG20 futures market, each of which corresponds to a group of institutional investors. Zhang and Urquhart (2018) set the transaction costs of pairs trading between mainland China and Hong Kong stock markets at 1% per trade. Qin et al. (2019) estimate the index arbitrage transaction costs to be 1.5% and 2.0% for brokers and institutional investors, respectively, for the CME Nikkei 225 futures. We follow these studies to ignore the time value of transaction costs for simplicity.
The margin set by the CME is $4,000 for a Nikkei 225 futures contract at the end of the sample.
Results are available on request. Unit root tests suggest that the absolute mispricing is stationary; these results are also available on request.
We further tried the following dummy variables in the regression. Negative basis could exert a larger effect on the size of mispricing than positive basis (Wang 2011). Thus, a dummy variable was added to the regression to check the possible asymmetric effect of basis. Additional dummy variables were added to check the effect of time-related anomalies, including the weekend effect and the mid-of-the-week effect, and whether there are monthly patterns recognizable in the mispricing series. We find that the dummy variables tend to be insignificant and make overparametrized models. This indicates that the asymmetric effect of basis, and the time-related patterns may not be important in the CME Nikkei market, and therefore these dummies are not included in Eq. (9).
We thank an anonymous reviewer for the suggestion.
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Acknowledgements
We wish to thank Christopher J. Green, Kavita Sirichand and two anonymous reviewers for helpful comments.
Funding
This work was supported by Natural Science Foundation of Anhui Province, China [grant number 2008085QG347].
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Appendix
Appendix
1.1 The Relative Stability of the Gensaki Rate
The Gensaki Treasury bill overnight rate is a proxy for the risk-free rate in the arbitrage-free quanto pricing model, Eqs. (5) and (6). Figure 7 shows that the Gensaki rate is relatively stable and fluctuations tend to be small given the scale of the vertical axis. The Gensaki rate is stochastic but the uncertainty about the rate is likely to be less important.
Time series of the Gensaki rate. This figure shows the Gensaki Treasury bill overnight rate on a daily basis over the sample. The annualized Gensaki rate is converted into a daily rate by dividing it by 365
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Qin, J. The Profitability and Arbitrage Efficiency of the Chicago Mercantile Exchange Nikkei 225 Futures. Asia-Pac Financ Markets (2024). https://doi.org/10.1007/s10690-024-09469-4
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DOI: https://doi.org/10.1007/s10690-024-09469-4