Informed trade in spot foreign exchange markets: an empirical investigation

This paper presents new evidence on information asymmetries in inter-dealer FX markets. We employ a new USD/DEM data set covering the activities of multiple dealers over one trading week. We utilise and extend the VAR structure introduced in Hasbrouck [J. Finance 46(1) (1991) 179] to quantify the permanent effects of trades on quotes and show that asymmetric information accounts for around 60% of average bid-ask spreads. Further, 40% of all permanent price variation is shown to be due to transaction-related information. Finally, we uncover strong time-of-day effects in the information carried by trades that are related to the supply of liquidity to D2000-2; at times when liquidity supply is high, individual trades have small permanent effects on quotes but the proportion of permanent quote variation explained by overall trading activity is relatively high. In periods of low liquidity supply the converse is true—individual trades have large permanent price effects but aggregate trading activity contributes little to permanent quote evolution.     

The determinants of bid-ask spreads in the foreign exchange futures market: A microstructure analysis

This paper investigates and analyzes the intraday and daily determinants of bid-ask spreads (BASs) in the foreign exchange futures (FXF) market. It is found that the number of transactions and the volatility of FXF prices are the major determinants. The number of transactions is negatively related to the BAS, whereas volatility in general is positively related to it. The study also finds that there are economies of scale in trading FXF contracts. The intraday BAS follows a U-shaped pattern, and they tend to be higher on Mondays and Tuesdays than on other days of the week. Higher spreads at the beginning and end of a trading day are consistent with the presence of adverse selection and the avoidance of the possibility of carrying undesirable inventory overnight, respectively. Seasonal differences in BASs that are related to the delivery date of a contract are also found. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 307–324, 1999     

Exchange traded contracts for difference: Design,pricing, and effects

Contracts for Difference (CFDs) are a significant financial innovation in the design of futures contracts. Over‐the‐counter trading in the UK is significant and has created controversy, but there is no published academic research into the design, pricing, and effects of CFDs. This study analyzes CFD contract design and pricing. It uses a unique database of trades and quotes on exchange traded equity CFDs introduced by the Australian Securities Exchange to test theoretical pricing relationships, and draws out implications for successful design and trading arrangements for the introduction of new derivative contracts. © 2010 Wiley Periodicals, Inc. Jrl Fut Mark     

Further analysis of the speed of response to large trades in interest rate futures

This study examines the adjustment process in the interest rate futures market following large block trades, by analyzing changes in the levels of quoted prices, bid‐ask spreads, and trading activity. Most of the adjustment in prices and spreads is complete within 12 quote revisions (approximately 70 seconds). Results suggest that block trades stimulate subsequent trading activity, as traders rush to express differences of opinion about the price implication of the block. The market response to block trades exhibits several features in common with the two‐phase response of the US treasury market to macroeconomic announcements described by Fleming, M. J. and Remolona, E. M. (1999). © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 30:705–724, 2010     

The impact of electronic trading on bid‐ask spreads: Evidence from futures markets in Hong Kong,London, and Sydney

During 1999 and 2000, three major futures exchanges transferred trading in stock index futures from open outcry to electronic markets: the London International Financial Futures and Options Exchange (LIFFE); the Sydney Futures Exchange (SFE); and the Hong Kong Futures Exchange (HKFE). These changes provide unique natural experiments to compare relative bid‐ask spreads of open outcry vs. electronically traded markets. This paper provides evidence of a decrease in bid‐ask spreads following the introduction of electronic trading, after controlling for changes in price volatility and trading volume. This provides support for the proposition that electronic trading can facilitate higher levels of liquidity and lower transaction costs relative to floor traded markets. However, bid‐ask spreads are more sensitive to price volatility in electronically traded markets, suggesting that the performance of electronic trading systems deteriorates during periods of information arrival. © 2004 Wiley Periodicals, Inc. Jrl Fut Mark 24:675–696, 2004     

The quality of volatility traded on the over‐the‐counter currency market: A multiple horizons study

Previous studies of the quality of market‐forecasted volatility have used the volatility that is implied by exchange‐traded option prices. The use of implied volatility in estimating the market view of future volatility has suffered from variable measurement errors, such as the non‐synchronization of option and underlying asset prices, the expiration‐day effect, and the volatility smile effect. This study circumvents these problems by using the quoted implied volatility from the over‐the‐counter (OTC) currency option market, in which traders quote prices in terms of volatility. Furthermore, the OTC currency options have daily quotes for standard maturities, which allows the study to look at the market's ability to forecast future volatility for different horizons. The study finds that quoted implied volatility subsumes the information content of historically based forecasts at shorter horizons, and the former is as good as the latter at longer horizons. These results are consistent with the argument that measurement errors have a substantial effect on the implied volatility estimator and the quality of the inferences that are based on it. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:261–285, 2003     

More shareholders,higher liquidity? Evidence from an emerging stock market

Using data assembled from all non-financial firms traded on the Malaysian stock exchange, we provide evidence of a nonlinear relationship between the number of shareholders and liquidity. While more shareholders are associated with higher liquidity, the negative effect of wider spreads kicks in when shareholder base exceeds a threshold level due to higher volatility induced by noise trading. However, the threshold level is considerably higher than the number of shareholders of most Malaysian public listed firms, suggesting much room for shareholder expansion in the local market. Our findings call for corporate managers to actively manage and expand their shareholder bases.     

Volatility trade design

Despite the fact that they are heavily traded, discussed in every derivatives text, and necessary to aligning implied volatilities with volatility expectations, volatility trades such as straddles, strangles, and option/asset combinations have received scant attention in the finance research literature. Using a unique data set for the Eurodollar options market, the trading and structure of seven volatility trades—straddles, strangles, option/asset combinations, guts, butterflies, iron butterflies, and condors—are examined. We find that both traders' choices among the seven strategies and the designs they choose for the individual strategies indicate that volatility traders seek designs with (1) low deltas, (2) low transaction costs, and (3) high gammas and vegas. Among other things, these three presumed objectives explain why butterflies, guts, and condors are rarely traded; covered call and put writing is rare; and straddles are the most popular volatility trade. These objectives also explain the usual design of straddles, strangles, and asset/option combinations and the straddle–strangle choice. Our data also indicate that, in constructing their spreads, traders rely on heuristics that lead to relatively low deltas and high gammas and vegas, but not always the lowest delta and highest gamma/vega constructions implied by more sophisticated models. We find little evidence of trading based on the shape of the smile, that is, little evidence that trades are designed to long (short) strikes with low (high) implied volatilities. We find that some volatility trade structures—those that (1) receive considerable attention in finance textbooks, (2) have been posited by finance researchers, or (3) are recognized by the exchanges—are rarely employed by traders, whereas others are quite common. © 2005 Wiley Periodicals, Inc. Jrl Fut Mark 25:243–279, 2005     

Market microstructure effects on volatility at the TAIFEX

This study examines whether changes in the frequency of market clearing or changes in trading hours on competing exchanges that use different auction systems affect the volatility of futures prices. In particular, this study exploits a natural experiment in the frequency of market clearing of stock index futures contracts traded on the Taiwan Futures Exchange (TAIFEX) to assess whether successive increases in the frequency of market clearing are associated with changes in the volatility of futures prices. The impact of changes in the trading hours on the TAIFEX and on the competing Singapore Exchange (SGX) where a similar Taiwanese stock index futures contract trades under a continuous auction market regime is also examined. The evidence for the impact of an increase in the frequency of market clearing on volatility is mixed. However, the introduction of simultaneous opening times for the TAIFEX (which batches orders at the open) and the SGX (which does not) is associated with a significant reduction in the volatility in SGX Taiwanese stock index futures prices. © 2007 Wiley Periodicals, Inc. Jrl Fut Mark 27:1219–1243, 2007     

BitMEX bitcoin derivatives: Price discovery,informational efficiency,and hedging effectiveness

BitMEX is the largest unregulated bitcoin derivatives exchange, listing contracts suitable for leverage trading and hedging. Using minute-by-minute data, we examine its price discovery and hedging effectiveness. We find that BitMEX derivatives lead prices on major bitcoin spot exchanges. Bid–ask spreads, interexchange spreads, and relative trading volumes are important determinants of price discovery. Further analysis shows that BitMEX derivatives have positive net spillover effects, are informationally more efficient than bitcoin spot prices, and serve as effective hedges against spot price volatility. Our evidence suggests that regulators prioritize the investigation of the legitimacy of BitMEX and its contracts.     

Intraday volatility in the bond,foreign exchange,and stock index futures markets

Intraday volatility for the Eurodollar, the Euro/dollar foreign exchange rate, and the E‐mini S&P 500 futures contracts traded on a continuous 23‐hour schedule on the Chicago Mercantile Exchange Globex electronic platform is studied. Volatility transmission in a single market across different regions is mainly explained by intraregion volatility (heat waves); interregion volatility (meteor showers) plays a secondary role. The joint impact of liquidity variables such as volume and open interest on volatility is also analyzed. Volume tends to increase volatility, but open interest does not affect it. The results are explained by the type of trading venue. Unlike floor‐based trading systems, in electronic markets open interest does not seem to provide additional information on market liquidity and its relation to volatility beyond any information contributed by volume. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:313– 334, 2008     

Liquidity supply and volatility: futures market evidence

This article examines the provision of liquidity in futures markets as price volatility changes. We find that customer trading costs do not increase with volatility. However, for three of the four contracts studied, the nature of liquidity supply changes with volatility. Specifically, for relatively inactive contracts, customers as a group trade more with each other and less with market makers, on higher volatility days. By contrast, for the most active contract, trading between customers and market makers increases with volatility. We also find that market makers' income per contract decreases with volatility for one of the least active contracts in our sample, but is not significantly affected by volatility for the other contracts. These results are consistent with the idea that, for high‐cost, inactive contracts, market makers react to temporary increases in volatility by raising their bid‐ask spreads significantly, and customers provide increased liquidity through standing limit orders. An implication of our results is that electronic systems, where market maker participation is not required, are able to supply adequate liquidity during volatile periods. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21:1–17, 2001     

The impact of time duration between trades on the price of treasury note futures contracts

Recent research in finance has indicated that the institutional structure in which financial asset prices are determined can have a nontrivial impact on pricing. This report examines transaction level data for Treasury Note futures contracts traded at the Chicago Board of Trade (CBOT) to identify institutional, or market microstructure, impacts on the pricing of these contracts. Relatively few articles have conducted empirical research on the microstructure of U.S. futures trading due to the limited availability of comprehensive transaction level data from the futures exchanges. This report uses the CBOT's Computerized Trade Reconstruction database, a comprehensive transaction level dataset, to identify the price impact of the time duration between trades in a manner analogous to that of A. Dufour and R. F. Engle (2000). Unique differences from prior research include the application to futures contracts with their relative higher frequency of trading, as well as the investigation of the price impact of the number of active traders present on the trading floor and the trading volume. Subsequent price and sign of trade significantly relate to the time duration between trades, the number of floor brokers, and the trading volume. © 2004 Wiley Periodicals, Inc. Jrl. Fut Mark 24:965–980, 2004     

Reputation-based pricing and price improvements

Dealers often offer price improvements, relative to posted quotes, to their clients. In this paper, we propose an explanation to this practice. We also analyze its effects on market liquidity and traders’ welfare. Enduring relationships allow dealers to avoid informed trades by offering price improvements to clients who do not trade with the dealer when they are informed. A dealer never observes whether a specific client is informed or not but he can avoid informed orders by conditioning his offers on past trading profits. Cream-skimming of uninformed order-flow increases the risk of informed trading for dealers without a relationship. Thus, authorizing price improvements increases bid-ask spreads and impairs the welfare of investors without a relationship. It may even decrease the welfare of investors who develop a relationship as they sometimes need to trade at posted quotes. The model predicts a positive relationship between (a) the price improvements granted to a specific investor and past trading profits with this investor or (b) the frequency of price improvements and bid-ask spreads.     

Public News Arrival and Cross‐Asset Correlation Breakdown

This study models and tests empirically the role of public news arrivals in the quote matching across single‐stock futures and underlying stock markets—a trading strategy often adopted by algorithmic traders. Our model suggests that quote return correlation across these two markets breaks down when the news uncertainty is sufficiently large and futures market makers switch from automating the quote matching process to manually analyze, monitor, and update quotes. We show empirically that the breakdown is more prominent for large stocks, and this effect of firm size falls during periods of high‐market volatility. Our empirical results are robust to the effect of distraction due to extraneous news events.     

Call Auction Transparency and Market Liquidity: Evidence from China

This paper uses the natural experiment offered by the Shanghai Stock Exchange to investigate the impact of opening call auction transparency on market liquidity. We find that the dissemination of indicative trade information during the pre‐open call auction session leads to an overall improvement in stock liquidity in the continuous trading session. Bid‐ask spreads narrow in the first trading hour because adverse selection risk fell significantly and there is less price volatility in the continuous market. This effect is greater for actively traded securities than illiquid securities. Our findings are robust for different lengths of sample period, different lengths of trading hours after market open, and stocks that had (and had not) reformed the share split structure during our research period.     

Volatility and trading demands in stock index futures

In this study we examine how volatility and the futures risk premium affect trading demands for hedging and speculation in the S&P 500 Stock Index futures contracts. To ascertain if different volatility measures matter in affecting the result, we employ three volatility estimates. Our empirical results show a positive relation between volatility and open interest for both hedgers and speculators, suggesting that an increase in volatility motivates both hedgers and speculators to engage in more trading in futures markets. However, the influence of volatility on futures trading, especially for hedging, is statistically significant only when spot volatility is used. We also find that the demand to trade by speculators is more sensitive to changes in the futures risk premium than is the demand to trade by hedgers. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:399–414, 2003     

The effect of multiple listings on the bid–ask spread in option markets: The case of Montreal Exchange

In this article, we examine the effect of multiple listings of options on their bid–ask spread, by comparing options contracts listed only on the Montreal Exchange with those interlisted on that exchange and on a U.S. exchange as well. Using a statistical procedure adapted to panel data and two models for the determination of the bid–ask spread, we find that the bid–ask spreads of Montreal options interlisted in U.S. markets are narrower than those of non‐interlisted options. That advantage tends to disappear, however, with an increase in option price and to increase with its volatility, but is not affected by the volume of transactions in the option market. The analysis also shows that interlisting may result in time lags in the convergence of quotes between Montreal and the U.S. markets. Moreover, our evidence shows that with interlisting, volume shifts to the option market where trading in the underlying security is concentrated, irrespective of the location where the option was first introduced. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:939–957, 2002     

Currency‐Protected Swaps and Swaptions with Nonzero Spreads in a Multicurrency LMM

Despite the fact that currency‐protected swaps and swaptions are widely traded in the marketplace, pricing models for zero‐spread swaps, and swaptions have rarely been examined in the extant literature. This study presents a multicurrency LIBOR market model and uses it to derive pricing formulas for currency‐protected swaps and swaptions with nonzero spreads. The resulting pricing formulas are shown to be feasible and tractable for practical implementation and their hedging strategies are also provided. Our pricing formulas provide prices close to those computed from Monte Carlo simulation, but involve far less computation time, and thereby offering almost instant price quotes to clients and daily marking‐to‐market trading books, and facilitating efficient risk management of trading positions.     

Examining futures price changes and volatility on the trading day after a limit‐lock day

This paper examines the effect that price limits have on futures prices by testing what happens to price changes and volatility on the trading day following a limit‐lock day. The results show evidence that prices continue to rise on average the day after an up‐limit day. In addition, limits appear to influence price volatility for some but not all of the futures contracts. However, since the findings vary across the different commodity futures contracts, it is likely that limits do not directly impact price volatility. © 2000 John Wiley & Sons, Inc. Jrl Fut Mark 20:445–466, 2000