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The CME Nikkei 225 "Quanto" futures contract settles against the Nikkei Index but taken to refer to US dollars. In contrast, the corresponding "Vanilla" instruments trading in Singapore and Osaka, settle in Yen. We show that the returns to the Quanto future are correlated with returns to the US market, as represented by the CME S&P500 future, even after controlling for the returns to the Vanilla contract, translated into dollars, and the dollar/Yen returns. This correlation is partially reversed the next day. This result goes against the usual analysis of Quanto instruments, which asserts that they can be hedged via the corresponding vanilla instrument, and a currency position. In fact, we show that our Quanto and Vanilla investment strategies should not differ in their currency exposure, and this is reflected in the significance of th...
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