Chicago Mercantile Exchange - Explained
What is the Chicago Mercantile Exchange?
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Table of ContentsWhat is the Chicago Mercantile Exchange?What Does the Chicago Mercantile Exchange Do?Academic Research on the Chicago Mercantile Exchange
What is the Chicago Mercantile Exchange?
The Chicago Mercantile Exchange (CME) is a Chicago-based facility that offers futures and options trading services in industry segments such as agribusiness, power, stock market index, currency, real estate and commodities. The Chicago Mercantile Exchange is the global leader in the derivatives market and has a diverse range of futures and options on offer.
What Does the Chicago Mercantile Exchange Do?
The Chicago Mercantile Exchange (CME) began operations as Chicago Board on Oil and Eggs in 1898. It acquired its present name in 1919. In 2000, CME transitioned into a demutualized, shareholder-owned corporation - the very first of its kind to do so. CMEs first futures contract was for frozen meat products in 1961. In 1969, the exchange incorporated financial futures and currency undertakings. Three years on, CME became the first exchange to offer interest rate, bond and futures undertakings. CMEs merger with the Chicago Chamber of Commerce in 2007 led to the creation of the CME Group as one of the largest financial exchanges anywhere. The following year saw the acquisition of NYMEX Holdings Inc. by the group. This was a significant move because it allowed CME Group to exercise control over both the New York Mercantile Exchange (NYMEX) as well as Commodity Exchange, Inc. (COMEX) - the two companies held by NYMEX Holdings. The CME Group went on to acquire a 90% majority stake in the Dow Jones Stock and Financials Indices in 2010, and followed it up by acquiring the Kansas City Board of Trade just two years later. In 2017, CME ventured into Bitcoin futures trading. The CME Group claims to process an average of three billion contracts per year, amounting to $1000 trillion, or roughly 15 times the GDP of the world! CMEs Globex electronic trading platform has ensured that 80% of all CME trading is electronically processed. CME Clearing is another subsidiary of the CME Group that provides central counterparty clearings. The unpredictable nature of global events makes it all the more necessary for financial managers and businesses to have anti-risk devices in place so as to lower the risks associated with negative price movements. Futures especially come in handy in such situations - forward contracts make it possible for sellers to know beforehand what price their products will sell for in the market. Similarly, futures also benefit buyers by giving them an accurate figure of what they will have to pay for products at a stipulated time in the future. The immense popularity of futures as hedging instruments cannot be underemphasized. However, speculators habitually take opposite sides, attempting to benefit from price fluctuations of commodities, while assuming all underlying risks typically associated with such endeavors. The CME Group offers a modulated, realizable and integrated mechanism for the trading of futures and options. Moreover, the family of futures exchanges also provides other trading services such as settlement, clearing and reporting.
Academic Research on the Chicago Mercantile Exchange
- On modelling and pricing weather derivatives, Alaton, P., Djehiche, B., & Stillberger, D. (2002). Applied mathematical finance, 9(1), 1-20. The goal of this paper is to obtain a pricing model for weather derivatives with dividends payable on fluctuating temperature. A stochastic process is formulated based on archival data, that explains the movement of temperature. However, since it is not possible to trade in temperature, traders usually obtain unique prices of contracts in incomplete markets by employing the market price of risk.
- Predicting volatility in the foreign exchange market, Jorion, P. (1995). The Journal of Finance, 50(2), 507-528. Jorions paper scrutinizes the predictive accuracy of Implied Standard Deviations (ISDs) derived from CME options on currency futures. It concludes that ISDs conveniently outperform conventional statistical timeseries models. However, this does not necessarily imply that ISDs are unbiased; in fact, there exists a high possibility of results being distorted by measurement inaccuracies and statistical complications.
- Optionimplied risk aversion estimates, Bliss, R. R., & Panigirtzoglou, N. (2004). The journal of finance, 59(1), 407-446. This paper measures the relative risk aversion (RRA) implied in prices of FTSE 100 and S&P 500 options by employing power and exponentialutility functions. It concludes that RRA estimates are conspicuously consistent at all tested horizons and across utility functions. It has been noted that RRA is remarkably lower during periods of market volatility.
- Real-time price discovery in global stock, bond and foreign exchange markets, Andersen, T. G., Bollerslev, T., Diebold, F. X., & Vega, C. (2007). Journal of international Economics, 73(2), 251-277. This paper demonstrates the correlation of high-frequency stock, bond and exchange rate dynamics with market fundamentals by sampling the reaction of high-frequency futures from U.S., German and British exchanges to real-time U.S. macroeconomic events. The authors conclude that news of such events produce different effects on equity markets depending on the stage of the business cycle.
- Weather derivatives and weather risk management, Brockett, P. L., Wang, M., & Yang, C. (2005). Risk Management and Insurance Review, 8(1), 127-140. This study scrutinizes weather derivatives and their role in coping with weather-induced risks. Newfound focus on the fast-growing weather derivatives market signifies the correlation of finance with insurance. In this paper, the authors review weather risks and weather derivatives, while emphasizing on: The evaluation of weather derivatives in an incomplete market; How hedging affects weather derivatives; Efficient weather hedging in view of the underlying risks.
- Mechanizing the Merc: The Chicago Mercantile Exchange and the rise of high-frequency trading, MacKenzie, D. (2015). Technology and Culture, 56(3), 646-675. This paper studies the history of trading automation at the Chicago Mercantile Exchange and outlines its consequences on modern-day high-frequency trading or HFT. CMEs mechanized automation had a direct impact on its trading practices. This leads the authors to compare this transition with that of the rival Chicago Board of Trade, which was perceived to have undergone a much more social process of automation.
- The impact of stock index futures on the Korean stock market, Ryoo, H. J., & Smith, G. (2004). Applied Financial Economics, 14(4), 243-251. Ryoo and Smiths paper scrutinizes the effect of trading in KOSPI 200 futures on the Korean stock market. It has already been established that trading in futures has a widespread effect on the cash market, including escalating market volatility. Also, there is a correlation between cash and futures prices, with strong substantiation of stock index futures market leading the cash market.
- The intraday interdependence structure between US and Japanese equity markets, Becker, K. G., Finnerty, J. E., & Tucker, A. L. (1992). Journal of Financial Research, 15(1), 27-37. This paper presents a correlation between lagged stock returns of American stock markets within two end of trading sessions and Japanese equity market returns within one trading session from open to close. However, this correlation is the most apparent during the opening hour of the Japanese trade session and the effect of lagged U.S. returns on the Japanese market reduces as the day progresses.
- Electronic trading on futures exchanges, Sarkar, A., & Tozzi, M. (1998). Current Issues in Economics and Finance, 4(1), 1. This study highlights the efficacy as well as the cost-effectiveness benefits of employing electronic trading systems in futures exchanges. It also tracks the impressive growth of such electronic systems in futures exchanges and predicts more rapid growth in the future.
- Effects of contract provisions on the success of a futures contract, Powers, M. J. (1967). Journal of Farm Economics, 49(4), 833-843. Powers paper scrutinizes the entry of hedgers into a futures market and tries to correlate it with contract provisions. The introduction of pork belly futures in 1961 essentially made Chicago Mercantile Exchange what it is today. However, these futures were slow sellers for the better part of two years. It was not until the introduction of revisions in contract provisions in the period 1962 - 63 that hedgers eventually made way into the market.
- The performance and market impact of dual trading: CME rule 552, Chang, E. C., & Loche, P. R. (1996). Journal of Financial Intermediation, 5(1), 23-48. Chang and Loches paper studies dual trading on futures contracts moderated by the CME and draws the conclusion that dual traders are the best brokers. This is because when unrestricted, dual brokers tend to execute mainly customer orders and ignore personal trades. However, there exists several categories of traders, each with their own set of strategies and profitability objectives.
- News announcements and price discovery in foreign exchange spot and futures markets, Chen, Y. L., & Gau, Y. F. (2010). Journal of Banking & Finance, 34(7), 1628-1636. Chen and Gau analyze Euro-to-U.S. Dollar and Japanese Yen-to-U.S. Dollar markets to understand competition in price discovery between spot and futures rates, especially during macroeconomic events. Sampling futures price data from both the CME as well as the Electronic Broking Services (EBS), the authors draw a correlation between news of drastic macroeconomic events and spot and futures rates. They conclude that spot rates typically enable better price discovery than futures rates.