The effect of net positions by type of trader on volatility in foreign currency futures markets

We investigate the effect of net positions by type of trader on return volatility in six foreign currency futures markets using the weekly Commitments of Traders (COT) data. When net positions are decomposed into expected and unexpected components, we find that expected net positions by type of trader generally do not co‐vary with volatility. However, volatility is positively associated with shocks (in either direction) in net positions of speculators and small traders, and negatively related to shocks (in either direction) in net positions of hedgers. This evidence suggests that changes in speculative positions destabilize the market. Consistent with dispersion of beliefs models and noise trading theories, hedgers appear to possess private information, whereas speculators and small traders are less informed in these markets. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:427–450, 2002     

Are speculators informed?

The positions of hedgers and speculators are correlated with returns in a number of futures markets, but there is much debate as to the interpretation of such a relationship—whether it reflects private information, liquidity, or trend‐chasing behavior. This paper studies the relationship between positioning of hedgers and speculators and returns in equity futures markets. I propose a novel test of the private information hypothesis: analyzing the effect of public announcements about futures positions on prices, using high‐frequency data in short windows around the announcements. I find that the revelation of speculators' positions is informative to investors more broadly, supporting the private information view. © 2011 Wiley Periodicals, Inc. Jrl Fut Mark     

Small traders in currency futures markets

This study examines the interrelation between small traders' open interest and large hedging and speculation in the Canadian dollar, Swiss franc, British pound, and Japanese yen futures markets. The results, based on Granger‐causality tests and vector autoregressive models, suggest that small traders' open interest is closely related to large speculators' open interest. Small traders and speculators tend to herd, which means that small traders are long [short] when speculators are long [short] as well. Moreover, small traders and speculators are positive feedback traders whereas hedgers are contrarians. Regarding information flows, speculators lead small traders in three of the four currency futures markets. The results therefore suggest that small traders are small speculators who follow the large speculators, indicating that they are less well informed than the large speculators. © 2010 Wiley Periodicals, Inc. Jrl Fut Mark 31:898–913, 2011     

When is informed trading more prevalent?—An examination of options trading around Indian M&A announcements

This study examines the prevalence of informed trading around proximate-date versus far-date mergers and acquisitions (M&As). Further, different options strategies pursued by informed traders in proximate-date M&As are identified. The results highlight that proximate-date M&As are associated with a significantly higher level of informed trading vis-à-vis far-date M&As. Results on the choice of options strategies highlight that risk-averse, informed traders may pursue a straddle strategy to profit from their private information, while risk-seeking, informed traders may use a vertical call spread strategy. Informed traders desirous of hedging their existing positions may employ a protective put strategy.     

Slow and fast markets

Informed traders need liquidity in order to profit from their private information. Markets provide liquidity and are compensated by the information released through trading. Fast markets provide access to a limit order book. Slow markets provide execution in an auction-based trading floor. Hybrid markets combine both execution venues. It is shown here that the overall efficiency of a hybrid market is determined by its fast component. The introduction of a trading floor does not generate more informed trading, only takes trading away from the fast market. Trading floors are thus inherently competitive to the fast market. We provide conditions that determine the competitiveness of a trading floor with respect to a fast market.     

Local trader profitability in futures markets: Liquidity and position taking profits

This study examines the profitability of local traders on floor‐traded futures markets. Using unique data from the period of floor trading on the Sydney Futures Exchange, local income is decomposed into liquidity and position‐taking profit components. Locals on the trading floor are found to make significant position‐taking profits. Moreover, the ability of locals on the floor to derive position‐taking profits is positively related to order‐flow related information, and negatively related to the presence of exogenous information, local liquidity profits and the length of a locals inventory cycle. Accordingly, this paper characterizes locals as active informed traders. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 30:1–24, 2010     

Nonlinear dynamics and competing behavioral interpretations: Evidence from intra‐day FTSE‐100 index and futures data

Extant empirical research has reported nonlinear behavior within arbitrage relationships. In this article, the authors consider potential nonlinear dynamics within FTSE‐100 index and index‐futures. Such nonlinearity can be rationalized by the existence of transactions costs or through the interaction between informed and noise traders. They consider several empirical models designed to capture these alternative dynamics. Their empirical results provide evidence of a stationary basis term, and thus cointegration between index and index‐futures, and the presence of nonlinear dynamics within that relationship. The results further suggest that noise traders typically engage in momentum trading and are more prone to this behavior type when the underlying market is rising. Fundamental, or arbitrage, traders are characterized by heterogeneity, such that there is slow movement between regimes of behavior. In particular, fundamental traders act more quickly in response to small deviations from equilibrium, but are reluctant to act quickly in response to larger mispricings that are exposed to greater noise trader price risk. © 2006 Wiley Periodicals, Inc. Jrl Fut Mark 26:343–368, 2006     

Is it time to reduce the minimum tick sizes of the E‐mini futures?

On the Chicago Mercantile Exchange (CME), so‐called “E‐mini” index futures contracts trade on the electronic GLOBEX trading system alongside the corresponding full‐size contracts that trade on the open outcry floor. This paper finds that the current minimum tick sizes of the E‐mini S&P 500 and E‐mini Nasdaq‐100 futures contracts act as binding constraints on the bid‐ask spreads by not allowing the spreads to decline to competitive levels. We also find that, while exchange locals trade very actively on GLOBEX, they do not tend to act as liquidity suppliers. Taken together, our empirical results suggest that it is time for the CME to consider decreasing the minimum tick sizes of the S&P 500 and Nasdaq‐100 E‐mini futures contracts. A tick size reduction is likely to result in lower trading costs in the E‐mini futures markets. © 2005 Wiley Periodicals, Inc. Jrl Fut Mark 25:79–104, 2005     

Corporate Disclosures: Strategic Donation of Information*

In this paper, we model a corporate insider's motivation of truthful pre‐trade disclosure of her private payoff‐relevant information. In a model in which disclosure has no efficiency gains like reduced cost of capital, no legal implications, and no signaling motivations, we show that a corporate insider may choose to disclose payoff‐relevant information as a means of maximizing her trading profits. This truthful disclosure is done pre‐trade and is beneficial to the corporate insider as it erodes the informational advantage of other traders with private information. This new rationale for public disclosure needs to be empirically tested by examining the trades of corporate insiders after, and not before, public disclosures.     

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.     

The impact of a pro‐rata algorithm on liquidity: Evidence from the NYSE LIFFE

This study investigates the impact of introducing a pure pro‐rata algorithm on the liquidity of the market for Euribor futures contracts on NYSE LIFFE. Results indicate that the Euribor market experiences deterioration in liquidity: (1) both best and total depth fall and (2) quoted spreads widen after the structural change. Results also reveal that the Euribor market becomes more active after the event; both trading volume and trade frequency increase substantially after the event. Finally, after the transition, liquidity demanders are more likely to submit smaller market orders. The reduction in depth and increase in quoted spreads suggest that liquidity demanders incur higher trade execution costs after the transition. In contrast, the transition is beneficial for the exchange since trading volume is higher under the new regime. © 2011 Wiley Periodicals, Inc. Jrl Fut Mark 32:660–682, 2012     

Trading and information in futures markets

This paper studies the trading behavior of different types of traders (customer type indicators [CTI's]) in corn futures. Nonmembers (CTI4) consume most of the intraday liquidity while local traders (CTI1) as market makers are its main provider. Both groups combine most of the intraday trading volume. Interday trading comes mainly from proprietary accounts (CTI2) and other local traders' trades (CTI3), reflecting their longer-term needs for hedging and speculation. Changes in the overnight positions of the general public (CTI4) and clearing members (CTI2) contribute mostly to daily price discovery, while the positions of CTI3 group reflect possible information advantage about future price movements.     

An examination of the complementary volume–volatility information theories

The volume–volatility relationship during the dissemination stages of information flow is examined by analyzing various theories relating volume and volatility as complementary rather than competing models. The mixture of distributions hypothesis, sequential arrival of information hypothesis, the dispersion of beliefs hypothesis, and the noise trader hypothesis all add to the understanding of how volume and volatility interact for different types of futures traders. An integrated picture of the volume–volatility relationship is provided by investigating the dynamic linear and nonlinear associations between volatility and the volume of informed (institutional) and uninformed (the general public) traders. In particular, the trading behavior explanation for the persistence of futures volatility, the effect of the timing of private information arrival, and the response of institutional traders to excess noise trading risk is examined. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:963–992, 2008     

The price impact of futures trades and their intraday seasonality

This study examines the price impact of futures trades and their intraday seasonality by analyzing the continuous trading session dataset of KOSPI 200 futures, including the opening and closing periods. For this purpose, the study analyzes the futures dataset that contains information on transaction times, trade directions, order sizes, and the types of investors initiating the transactions. The results suggest several novel findings. First, a substantial portion of the price impact of futures trades is persistent, indicating the presence of informed trading in the futures market. Second, informed trading is concentrated in the opening period and liquidity trading is concentrated in the closing period of the continuous trading session. Third, small trades usually have a greater price impact than large ones, supporting the existence of stealth trading by futures traders. Fourth, trades by institutional investors have a greater price impact than those by individuals, suggesting that institutional investors are better informed and/or more sophisticated than individual investors in the futures market.     

Are single stock futures used as an alternative during a short‐selling ban?

The response of the single stock futures (SSF) market to a short‐selling ban is investigated. The hypothesis is that traders use SSF as a substitute instrument for short‐selling. A significant increase in SSF trading activity is documented, accompanied by narrower spreads. SSF market volatility did not react during the ban, which suggests that the increased trading activity did not weaken SSF market quality. The quality of the underlying market during the ban period is also assessed, with the results suggesting that changes in SSF market activity had neither positive nor negative effects on the stocks’ liquidity, volatility, and volume.     

Execution quality in open‐outcry futures markets

This study examines the composition of customer order .flow and the execution quality for different types of customer orders in six futures pits of the Chicago Mercantile Exchange (CME). It is shown that off‐exchange customers frequently provide liquidity to other traders by submitting limit orders. The determinants of customers' choice between limit and market orders are examined, and it is found that higher bid—ask spreads increase the limit‐order submission frequency, and increased price volatility makes limit‐order submission less likely. Effective spreads, trading revenues, and turnaround times for customer liquidity‐demanding and limit orders are also documented. Consistent with evidence from equity markets, the results show that limit‐order traders receive better executions than traders using liquidity‐demanding orders, but incur adverse selection costs. © 2005 Wiley Periodicals, Inc. Jrl Fut Mark 25:1067–1092, 2005     

Hedging long‐term commodity risk

This study focuses on the problem of hedging longer‐term commodity positions, which often arises when the maturity of actively traded futures contracts on this commodity is limited to a few months. In this case, using a rollover strategy results in a high residual risk, which is related to the uncertain futures basis. We use a one‐factor term structure model of futures convenience yields in order to construct a hedging strategy that minimizes both spot‐price risk and rollover risk by using futures of two different maturities. The model is tested using three commodity futures: crude oil, orange juice, and lumber. In the out‐of‐sample test, the residual variance of the 24‐month combined spot‐futures positions is reduced by, respectively, 77%, 47%, and 84% compared to the variance of a naïve hedging portfolio. Even after accounting for the higher trading volume necessary to maintain a two‐contract hedge portfolio, this risk reduction outweighs the extra trading costs for the investor with an average risk aversion. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:109–133, 2003     

Do single‐stock circuit breakers provide a safety net for Canadian investors?

This study looks at the market impact of recent regulatory changes in Canada that provide for trading halts on individual stocks that experience large upside or downside movements. The focus is on all stocks traded on the Toronto Stock Exchange since the inception of the single‐stock circuit breaker rule (SSCB) in February 2012, to replace the short‐sale uptick rule. The results support pricing efficiency: material information that caused the circuit breaker is incorporated in stock prices on the day of the halt (neither overreaction nor underreaction), with no decline in market liquidity. Using trade‐by‐trade data constructed on five‐minute trading intervals, we refine the daily results, and show that shocks in realized volatility are focused in the 10‐minute trading interval surrounding the halts. While circuit breakers provide a limited safety net for investors when their stocks are subject to severe volatility, they do not allow for a quick turnaround for stocks experiencing severe price decline events.     

Need for speed: Hard information processing in a high‐frequency world

I study the role of high‐frequency traders (HFTs) and non‐high‐frequency traders (nHFTs) in transmitting hard price information from the futures market to the stock market using an index arbitrage strategy. Using intraday transaction data with HFT identification, I find that HFTs process hard information faster and trade on it more aggressively than nHFTs. In terms of liquidity supply, HFTs are better at avoiding adverse selection than nHFTs. Consequently, HFTs enhance the linkage between the futures and stock markets, and significantly contribute to information efficiency in the stock market by reducing the delay between the stock and the futures markets.     

Duration,trading volume and the price impact of trades in an emerging futures market

This paper examines the price impact of trading intensity on the MexDer TIIE28 interest rate futures contract, one of the world's most actively traded contracts. A novel volume-augmented duration model of price discovery decomposes trading intensity into liquidity and information components. Duration between transactions exerts a positive influence on price changes, while increases in order flow and trade volume exert positive and negative influences, respectively. The liquidity component dominates the information measure, suggesting that liquidity considerations dictate trade timing. These findings are rationalized with reference to MexDer's organizational structure, specifically the affirmative obligations placed upon marketmakers to trade a minimum volume.