Index Futures and Predictability of the Underlying Stocks' Returns: The Case of the Nikkei 225

Abstract

Theories predict that launching index futures could affect the price informativeness for the underlying stocks. We test this hypothesis by taking advantage of the introduction of the Nikkei 225 futures contracts in Singapore on September 3, 1986. Employing two alternative statistical methods applied to both daily and weekly data, we find that, following the listing of the index futures, returns become significantly more random and less predictable for the underlying stocks, even after controlling for concurrent marketwide shifts. These findings suggest improved price informativeness for the underlying stocks, which is further corroborated by their higher trading volume following the event.

Keywords: Nikkei 225 futures, underlying stocks, return predictability, price informativeness

JEL Classification: G13, G14, G15