ecent years have witnessed an explosion in the variety of derivative assets traded R on securities markets. Interestingly, financial futures trading has only recently established a toehold in Japan. This is surprising because, by some measures, Japan's equity markets are the world's largest and the country is home to enormous institutional investors. However, regulatory barriers are gradually being dismantled and several futures markets based on Japanese stocks and government bonds are already operating.
This paper examines available data on Japanese stock index contracts and provides preliminary empirical evidence on a variety of pricing relationships. An understanding of the behavior of the new Japanese markets is essential because the international investment community is likely to find Japanese stock index contracts increasingly popular and important in coming years. The paper is organized as follows. Section I describes the history and institutional details of the Nikkei 225 and Stock 50 contracts. Section I1 describes the data set of market prices and trading volumes and presents summary information on futures trading volumes and returns on the underlying stock averages. Section I11 investigates the relationship between changes in the stock averages and futures contract trading volume. Section IV examines the power of cost-of-carry and continuous-time futures pricing models to predict market prices. Section V tests the effectiveness of the contracts in hedging against changes in the value of the underlying index.
I. Japanese Index Contracts: History and Institutional Details
Commodity futures have a long history in Japan. An informal market for rice warehouse receipts in Osaka evolved into an organized rice futures market in 1730.' Rice, soybeans, dried silkworm cocoons, and other commodities have traded on established exchanges for several decades.' Financial futures have a less distinguished history and reputation due to a series of futures markets collapses in the 1930'~.