The CME Quanto Nikkei Future: Does it Reveal International Market Segmentation?

Abstract

The CME Nikkei 225 futures contract settles against the Nikkei Index but taken to refer to US dollars. This is intended for the convenience of US investors wanting to take exposure to the Japanese Market. In contrast, the corresponding instruments trading on SIMEX (Singapore) and the OSE (Osaka, Japan), settle in Yen. We study whether the pricing of this Quanto contract reveals international market segmentation; in particular, whether its returns are correlated with the returns to the S&P500 future, which also trades on the CME, after controlling for the returns of either of the Vanilla contracts, and any currency exposure. Our first test is an OLS regression, including the one period ahead Vanilla return, to account for the time lag between the CME and SIMEX or the OSE, and this suggests that there is a segmentation effect. However, we show that this test suffers from an errors-in-variables problem, and is biased. We construct an unbiased GMM type test, which reveals that there is no segmentation effect, and supports the notion that the Quanto contract pricing is efficient. We also show empirically, and justify theoretically, that the Quanto and Vanilla futures contracts to not differ in their currency exposure, if the Yen cash flows from the Vanilla contract are immediately converted into dollars.