Determinants of Nikkei futures mispricing in international markets: dividend clustering, currency risk, and transaction costs

This paper develops a comprehensive modified cost of carry model to study the mispricing of Nikkei 225 index futures contracts traded in Osaka, Singapore and Chicago based on a new 19-year dataset. Using this improved model, we find that dividend clustering, currency risk and transaction costs all play an essential role in the estimation of Nikkei mispricing. An exponential smooth transition autoregressive (ESTAR)-GARCH model is used to describe the international dynamics of Nikkei mispricing. The results indicate that generally mean reversion in mispricing and limits to arbitrage are driven more by transaction costs than by heterogeneous investors.