How Japan lost Nikkei Futures

Business to Singapore

Case Presentation by
Marko Maric, Christian Hattendorff, Katharina Dragon, David Feierabend,
Benjamin Guin, Oliver Krebs, Toni Komljenovic, Lena Hoefling

Nikkei Case Analysis

 index value

10000
15000
20000
25000
30000
35000
40000
45000

5000

0
05/ 60

Nikkei Case Analysis

05/ 62

05/ 64

05/ 66

05/ 68

05/ 70

05/ 72

05/ 74

05/ 76

05/ 78

05/ 80

05/ 82
Nikkei 225 – time series

time
05/ 84

05/ 86

05/ 88

05/ 90

05/ 92

05/ 94

05/ 96

05/ 98

05/ 00

05/ 02

05/ 04

05/ 06

05/ 08
 index value

5000
10000
15000
20000
25000
30000
35000
40000
45000

0
05/ 60

Nikkei Case Analysis

05/ 62

05/ 64

05/ 66

05/ 68

05/ 70

05/ 72

05/ 74

05/ 76

05/ 78

05/ 80

05/ 82

time
05/ 84

05/ 86

05/ 88

05/ 90
Nikkei 225 – time series: increasing

05/ 92

05/ 94
trend (exponential growth 1960 – 1990)

05/ 96

05/ 98

05/ 00

05/ 02

05/ 04

05/ 06

05/ 08
 index value

0
5000
10000
15000
20000
25000
30000
35000
40000
45000
05/ 60

Nikkei Case Analysis

05/ 62

05/ 64

05/ 66

05/ 68

05/ 70

05/ 72

05/ 74

05/ 76

05/ 78

05/ 80
linear trend (1990 – today)

05/ 82

time
05/ 84

05/ 86

05/ 88

05/ 90
Nikkei 225 – time series: decreasing

05/ 92

05/ 94

05/ 96

05/ 98

05/ 00

05/ 02

05/ 04

05/ 06

05/ 08
Forecast 1986 - present

• xt=xt-1*eσ*Z

• Z: standard normal distributed random variable

• σ: Stdev log diff (1960-1980)

Nikkei Case Analysis

 10000
15000
20000
25000
30000
35000
40000
45000

5000

0
Aug 86

Aug 87

Nikkei Case Analysis

Aug 88

Aug 89

Aug 90

Aug 91

Aug 92

Aug 93

Aug 94

Aug 95

Aug 96

Aug 97
Forecast 1986 - present

Aug 98

Aug 99

Aug 00

Aug 01

Aug 02

Aug 03

Aug 04

Aug 05

Aug 06

Aug 07

Aug 08
ACTUALS

NO DRIFT
Forecast 1986 - present

• xt=xt-1*eσ*Z+μ

• Z: standard normal distributed random variable

• σ: Stdev log diff (1960-1980)
• μ: trend constant (1960-1980)

Nikkei Case Analysis

 100000
150000
200000
250000
300000

50000

0
Aug 86

Aug 87

Aug 88

Nikkei Case Analysis

Aug 89

Aug 90

Aug 91

Aug 92

Aug 93

Aug 94

Aug 95

Aug 96

Aug 97

Aug 98

Aug 99
Forecast 1986 - present

Aug 00

Aug 01

Aug 02

Aug 03

Aug 04

Aug 05

Aug 06

Aug 07

Aug 08
WITH
DRIFT
ACTUALS
Real Japanese GDP growth

0
83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07
19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20

-2

-4

Nikkei Case Analysis

Goodness of fit

• Model without drift:

69,4 %

• Model with drift:

1207,7 %

• Calculated as:
1/T Σ (forecasted value / actual value)

Nikkei Case Analysis

Efficient Market Hypothesis
Hypothesis:
A market is informationally efficient if the prices reflect all known
information and rapidly change to reflect new information.

• Eugene Fama 1960’s

• There is no possibility for investors to systematically achieve an above-

average return and to outperform the market

• Market inefficiencies are small, limited in time and predictable

• Arbitrage processes eliminate market inefficiencies

Nikkei Case Analysis

Efficient Market Hypothesis

3 types of market efficiencies

• Weak-form efficiency:
Includes historic share prices
Technical analysis obsolete
• Semi-strong-form efficiency:
Includes all public information
Fundamental analysis obsolete
• Strong-form efficiency:
Includes all public and private information
Even insider information obsolete

Nikkei Case Analysis

Efficient Market Hypothesis

Criticism
• Strong-form efficiency even theoretically impossible (information
paradoxon: Grossman/ Stiglitz)
• Financial business spends money for technical and fundamental
analysis
• Alternative explanation: Behavioral Finance (Cognitive Bias)

Nikkei Case Analysis

• We made a technical analysis, based on the historic index data
• If we follow the weak-form efficiency, the forecasts are more or less
obsolete

Nikkei Case Analysis

Execution Risk

In processing a securities transaction,

execution risk refers to the possibility that the market price
moves between the time an order is initiated and when it is
executed, resulting in execution worse what was expected and
thus resulting in loss or reduced profit.

Although such risk is minimal, execution risk refers to the

specific possibility that an exchange traded transaction may be
imperfect.

Nikkei Case Analysis

 Arbitrage

• Two markets, two prices, same product!

• Nikkei 225 futures price at Osaka Exchange (OE): 17,600
• Nikkei 225 Futures price at SIMEX: 17,580

→ Buy 10 contracts at SIMEX: 10 * 17,580 * 500 Yen= 87900000 Yen

→ Sell 10 contracts at OE: 10 * 17,600 * 500 Yen= 88000000 Yen
→ Arbitrage gain: 100000 Yen

→ So the arbitrage gain consisting of net margin payments during the

time to maturity is locked in.

Nikkei Case Analysis

 Payoff functions at maturity date

)
EX
Sh

M
or

(SI
ss

tp

on
Lo

os
n/

siti
iti
ai
G

on

po
(O

ng
E)

Lo
Gain 100,000Yen

Nikkei course *500Yen

88,000,000Yen

87,900,000Yen

Nikkei Case Analysis

 Lock in of loss as the prices moved against traders
between the initiation an the execution
of the two orders

)
EX
Sh

M
ss

or

(SI
Lo

tp
n/

on
ai

os

siti
G

iti

po
on

ng
(O

Lo
E)

0
Nikkei course *500 Yen
87,900,000 Yen
88,000,000 Yen
Loss 100,000 Yen

Nikkei Case Analysis

 Short-Selling

• In finance, short selling is the practice of selling assets, usually

securities, that have been borrowed from a third party with
the intention of buying identical assets back at a later date to
return them to the lender.

• The short seller hopes to profit from a decline in the value of

the assets, when he will pay less to repurchase the assets
than he received on selling them.

• Shorting and going short also refer to entering into derivative

contracts with an equivalent economic effect.

Nikkei Case Analysis

 Characteristic scenario of short-selling
An investor expects falling price of an asset:

Borrow and sell the asset at 500$/share

500

Ga
20 in
0$
/ sh
Price

ar
e

Buy and return the asset at 300$/share

300

Maturity date t

Nikkei Case Analysis

 Benefits of short-selling

• Both, borrower and lender can earn money although the

course of the underlying decreases

• No margin payments have to be made

• Extra cash after selling the borrowed assets that might be

invested in some profitable assets

Nikkei Case Analysis

 Drawbacks of short-selling

• Borrowing the underlying asset might be too

expensive

• Extremely risky position, losses if the price of the

underliyng goes up

Nikkei Case Analysis

 Alternatives

• Short position in futures on the same underlying

asset

• Short position in calls and long position in puts on

the same underlying and with the same maturity
date and same strike price. The premiums of short
and long options offset each other

Nikkei Case Analysis

 Things that need to match to make short-selling
and shorting futures have the same effect

• Number of underlying units borrowed = futures contract size

(standardized)

• Spot price at the time of borrowing = Futures price

• Timespan until returning the borrowed underlying to the

lender = futures time to maturity

Nikkei Case Analysis

Three financial strategies for
trading Nikkei 225 futures

1. Exclusive trading of Nikkei 225 at CME

• least risk for Japan, but only small rewards

2. Exclusive trading in local market (Osaka)

• problems: lack of customer base, experienced traders and
Chicago’s market expertise

3. Allow CME to trade without granting an exclusive right

(middle-of-the-road approach)
• contract signed in 1985
• a second market for trading Nikkei 225 futures was
developed in Osaka

Nikkei Case Analysis

Pros and Cons of the chosen contract
with CME

Pros
• trading of Nikkei 225 futures was succesful
• open outcry trading system of Chicago preferred to computer trading
at Osaka by some Japanese traders

Cons
• 14 hours time difference between Chicago and Tokyo
→ no arbitrage possibilities
→ Japanese traders could not conveniently access CME during
business hours in Japan

Nikkei Case Analysis

Result

SIMEX (Singapore International Monetary Exchange) decided

to offer its own Nikkei 225 futures contract

• SIMEX has an open outcry system

• small time difference between Singapore and Osaka

→ convenient trading for Japanese traders
→ arbitrage possibilities
• but: possible competition between the three markets

Nikkei Case Analysis

 Result

• Still, Singapore market less competitive due to favourable

growth enhancing conditions for Chicago and Osaka Exchange
markets

• In 1992: imposition of severe restrictions on the options and

futures contract trades
– High maintenance margins on deposits with the exchange
– Minimum commission rates for the dealer
 by 1996, Osaka and Singapore exchange markets have
become equally important for trading Nikkei 225 futures

Nikkei Case Analysis 27

 How can Osaka protect itself from
competition with SIMEX and CME?

• Introduction of open outcry mechanism?

• Training programs for staff in order to improve competitive
advantage?
• Offering non-fungible Nikkei 225 futures as did SIMEX in
1986?
• Tackle liquidity problem?

• Reverse legislation from 1992?!

Nikkei Case Analysis 28

Table I: List of companies included
in Nikkei 225
Companies Sector

Advantest Corp. Elektronik

Aeon Æon Co., Ltd. Einzelhandel

Ajinomoto Co., Inc. Nahrungsmittel

All Nippon Airways Co., Ltd. Luftfahrt

Alps Electric Co., Ltd. Elektronik

Asahi Breweries, Ltd. Nahrungsmittel

Asahi Glass Co., Ltd. Glas & Keramik

Asahi Kasei Corp. Chemie

Astellas Pharma Inc. Pharma

Bank of Yokohama The Bank of Yokohama, Ltd. Bank

Canon Inc. Elektronik

Casio Computer Co., Ltd. Elektronik

Chiba Bank, Ltd. Bank

Chiyoda Corp. Maschinen

Chubu Electric Power Co., Inc. Strom

Chugai Pharmaceutical Co., Ltd. Pharma

Chuo Mitsui Trust Holdings, Inc. Bank

Citizen Holdings, Ltd. Präzisionsgeräte

Clarion Co., Ltd. Elektronik

COMSYS Holdings Corp. Bau

Credit Saison Co., Ltd. Sonstige Finanzdienstleistungen

Nikkei Case Analysis

 Companies Sector

CSK Holdings Corp. Dienstleistungen

Daiichi Sankyo Co., Ltd. Pharma

Dai Nippon Printing Co., Ltd. Sonstige Industrie

Daikin Industries, Ltd. Maschinen

Dainippon Sumitomo Pharma Co., Ltd. Pharma

Daiwa House Industry Co., Ltd. Bau

Daiwa Securities Group Inc. Investment

Denki Kagaku Kogyo K.K. Chemie

Denso Corp. Elektronik

Dentsu Inc. Dienstleistungen

East Japan Railway Co. Eisenbahn & Bus

Ebara Corp. Maschinen

Eisai Co., Ltd. Pharma

Fanuc Ltd. Elektronik

Fast Retailing Co., Ltd. Einzelhandel

Fuji Electric Holdings Co., Ltd. Elektronik

Fuji Heavy Industries Ltd. Automobil

Fujifilm Holdings Corp. Chemie

Fujikura Ltd. NE-Metalle

Fujitsu Ltd. Elektronik

Fukuoka Financial Group Inc. Bank

Nikkei Case Analysis

 Companies Sector

Furukawa Co., Ltd. NE-Metalle

The Furukawa Electric Co., Ltd. NE-Metalle

GS Yuasa Corporation Elektronik

Heiwa Real Estate Co., Ltd. Immobilien

Hino Motors, Ltd. Automobil

Hitachi, Ltd. Elektronik

Hitachi Construction Machinery Co., Ltd. Maschinen

Hitachi Zosen Corp. Maschinen

Papier
Hokuetsu Paper Mills, Ltd.

Honda Motor Co., Ltd. Automobil

Isetan Mitsukoshi Holdings Ltd. Einzelhandel

IHI Corp. Maschinen

INPEX Corp. Bergbau

Isuzu Motors Ltd. Automobil

Itochu Corp. Handelshaus

J. Front Retailing Co., Ltd. Einzelhandel

Japan Airlines Corp. Luftfahrt

The Japan Steel Works, Ltd. Maschinen

Japan Tobacco Inc. Nahrungsmittel

JFE Holdings, Inc. Stahl

JGC Corp. Bau

JTEKT Corp. Maschinen

Nikkei Case Analysis

 Companies Sector

Kajima Corp. Bau

The Kansai Electric Power Co., Inc. Strom

Kao Corp. Chemie

Kawasaki Heavy Industries, Ltd. Schiffbau

Kawasaki Kisen Kaisha, Ltd. Schifffahrt

KDDI Corp. Kommunikation

Keio Corp. Eisenbahn & Bus

Keisei Electric Railway Co., Ltd. Eisenbahn & Bus

Kikkoman Corporation Nahrungsmittel

Kirin Holdings Co. Ltd. Nahrungsmittel

Komatsu Ltd. Maschinen

Konami Corp. Dienstleistungen

Konica Minolta Holdings, Inc. Präzisionsgeräte

Kubota Corp. Maschinen

Kuraray Co., Ltd. Chemie

Kyocera Corp. Elektronik

Kyowa Hakko Kirin Co., Ltd. Pharma

Marubeni Corp. Handelshaus

Maruha Nichiro Holdings, Inc. Fischerei

Marui Group Co., Ltd. Einzelhandel

Matsui Securities Co., Ltd. Investment

Nikkei Case Analysis

 Companies Sector

Mazda Motor Corp. Automobil

Meidensha Corp. Elektronik

Meiji Holdings Co., Ltd. Nahrungsmittel

Minebea Co., Ltd. Elektronik

Mitsubishi Chemical Holdings Corp. Chemie

Mitsubishi Corp. Handelshaus

Mitsubishi Electric Corp. Elektronik

Mitsubishi Estate Co., Ltd. Immobilien

Mitsubishi Heavy Industries, Ltd. Maschinen

Mitsubishi Logistics Corp. Lagerhaltung

Mitsubishi Motors Corp. Automobil

Mitsubishi Paper Mills Ltd. Papier

Mitsubishi Rayon Co., Ltd. Textilien

Mitsubishi UFJ Financial Group, Inc. Bank

Mitsui & Co., Ltd. Handelshaus

Mitsui Chemicals, Inc. Chemie

Mitsui Engineering & Shipbuilding Co., Ltd. Schiffbau

Mitsui Fudosan, Co. Ltd. Immobilien

Mitsui Mining & Smelting Co., Ltd. NE-Metalle

Mitsui O.S.K. Lines, Ltd. Schifffahrt

Mitsui Sumitomo Insurance Group Holdings, Inc. Versicherung

Nikkei Case Analysis

 Companies Sector

Mitsumi Electric Co., Ltd. Elektronik

Mizuho Financial Group, Inc. Bank

Mizuho Trust & Banking Co. Bank

NEC Corp. Elektronik

NGK Insulators, Ltd. Glas & Keramik

Nichirei Corp. Nahrungsmittel

Nikon Corp. Präzisionsgeräte

Nippon Express Co., Ltd. Sonstiger Verkehr

Nippon Kayaku Co., Ltd. Chemie

Nippon Light Metal Co., Ltd. NE-Metalle

Nippon Mining Holdings, Inc. Öl & Kohle

Nippon Oil Corp. Öl & Kohle

Nippon Paper Group, Inc. Papier

Nippon Sheet Glass Co., Ltd. Glas & Keramik

Nippon Soda Co., Ltd. Chemie

Nippon Steel Corp. Stahl

Nippon Suisan Kaisha, Ltd. Fischerei

Nippon Telegraph and Telephone Corp. Kommunikation

Nippon Yusen K.K. Schifffahrt

Nissan Chemical Industries, Ltd. Chemie

Nissan Motor Co., Ltd. Automobil

Nikkei Case Analysis

 Companies Sector

Nisshin Seifun Group Inc. Nahrungsmittel

Nisshinbo Industries, Inc. Textilien

Nitto Boseki Co., Ltd. Glas & Keramik

Nomura Holdings, Inc. Investment

NSK Ltd. Maschinen

NTN Corp. Maschinen

NTT Data Corp. Kommunikation

NTT DoCoMo, Inc. Kommunikation

Obayashi Corp. Bau

Odakyu Electric Railway Co., Ltd. Eisenbahn & Bus

Oki Electric Industry Co., Ltd. Elektronik

Okuma Corp. Maschinen

Olympus Corp. Präzisionsgeräte

Osaka Gas Co., Ltd. Gas

Pacific Metals Co., Ltd. Stahl

Panasonic Corp. Elektronik

Panasonic Electric Works Co., Ltd. Elektronik

Pioneer Corp. Elektronik

Resona Holdings, Inc. Bank

Ricoh Co., Ltd. Präzisionsgeräte

SANYO Electric Co., Ltd. Elektronik

Nikkei Case Analysis

 Companies Sector

Sapporo Holdings Ltd. Nahrungsmittel

Secom Co., Ltd. Dienstleistungen

Sekisui House, Ltd. Bau

Seven & i Holdings Co., Ltd. Einzelhandel

Sharp Corp. Elektronik

Shimizu Corp. Bau

Shin-Etsu Chemical Co., Ltd. Chemie

Shinko Securities Co., Ltd. Investment

Shinsei Bank, Ltd. Bank

Shionogi & Co., Ltd. Pharma

The Shizuoka Bank, Ltd. Bank

Showa Denko K.K. Chemie

Showa Shell Sekiyu K.K. Öl & Kohle

SKY Perfect JSAT Holdings Inc. Kommunikation

SoftBank Corp. Kommunikation

Sojitz Corp. Handelshaus

Sompo Japan Insurance, Inc. Versicherung

Sony Corp. Elektronik

SUMCO Corp. NE-Metalle

Sumitomo Chemical Co., Ltd. Chemie

Sumitomo Corp. Handelshaus

Nikkei Case Analysis

 Companies Sector

Sumitomo Electric Industries, Ltd. NE-Metalle

Sumitomo Heavy Industries, Ltd. Maschinen

Sumitomo Metal Industries, Ltd. Stahl

Sumitomo Metal Mining Co., Ltd. NE-Metalle

Sumitomo Mitsui Financial Group Inc. Bank

Sumitomo Osaka Cement Co., Ltd. Glas & Keramik

Sumitomo Realty & Development Co., Ltd. Immobilien

The Sumitomo Trust and Banking Co., Ltd. Bank

Suzuki Motor Corp. Automobil

T&D Holdings, Inc. Versicherung

Taisei Corp. Bau

Taiyo Yuden Co., Ltd. Elektronik

Takara Holdings Inc. Nahrungsmittel

Takashimaya Co., Ltd. Einzelhandel

Takeda Pharmaceutical Co., Ltd. Pharma

TDK Corp. Elektronik

Teijin Ltd. Textilien

Terumo Corp. Präzisionsgeräte

Tobu Railway Co., Ltd. Eisenbahn & Bus

Toho Co., Ltd. Dienstleistungen

Toho Zinc Co., Ltd. NE-Metalle

Nikkei Case Analysis

 Companies Sector

Tokai Carbon Co., Ltd. Glas & Keramik

Tokio Marine Holdings, Inc. Versicherung

Tokyo Dome Corp. Dienstleistungen

The Tokyo Electric Power Co., Inc. Strom

Tokyo Electron Ltd. Elektronik

Tokyo Gas Co., Ltd. Gas

Tokyu Corp. Eisenbahn & Bus

Tokyu Land Corp. Immobilien

Toppan Printing Co., Ltd. Sonstige Industrie

Toray Industries, Inc. Textilien

Toshiba Corp. Elektronik

Tosoh Corp. Chemie

Toto, Ltd. Glas & Keramik

Toyo Seikan Kaisha, Ltd. NE-Metalle

Toyobo Co., Ltd. Textilien

Toyota Motor Corp. Automobil

Toyota Tsusho Corp. Handelshaus

Trend Micro Inc. Dienstleistungen

Ube Industries, Ltd. Chemie

Unitika Ltd. Textilien

Uny Co., Ltd. Einzelhandel

Nikkei Case Analysis

 Companies Sector

West Japan Railway Co. Eisenbahn & Bus

Yahoo Japan Corp. Dienstleistungen

Yamaha Corp. Sonstige Industrie

Yamato Holdings Co., Ltd. Sonstiger Verkehr

Yokogawa Electric Corp. Elektronik

The Yokohama Rubber Co., Ltd. Gummi

Yahoo Japan Corp. Dienstleistungen

Yamaha Corp. Sonstige Industrie

Yamato Holdings Co., Ltd. Sonstiger Verkehr

Yokogawa Electric Corp. Elektronik

The Yokohama Rubber Co., Ltd. Gummi

Nikkei Case Analysis

 Table III: SIMEX Nikkei 225 -
Contract Specifications

• Symbol - NX
• Name - SIMEX Nikkei 225
• Exchange - SIMEX
• Trading Months - H,M,U,Z (March, June, September, December)
• Trading Unit - ¥ 500 times Nikkei 225 stock Index futures price
• Trading Hours - 7:55a.m. to 10:15a.m. and 11:15a.m. to 2:25p.m. and
3:00p.m. - 7:00p.m. (Singapore time)
• Tick Size - 5 points (¥ 2,500)
• Daily Limit - 7.5% from previous day's settlement price, followed by 15 min
cooling off period then 12.5%
• Last Trading Day - The day before the second Friday of the contract month
• Value of one futures unit - *-N/A
• Value of one options unit - *-N/A

Nikkei Case Analysis 40