Intraday behavior of market depth in a competitive dealer market: A note

This study is the first to examine the intraday behavior of quoted depth in a competitive dealer market. In sharp contrast to previous research that focuses on specialist markets, quoted depth is lowest at the open of trading, plateaus around the middle of the day, and then dramatically increases in the final hours of trading, peaking at the close. This peak in quoted depth coincides with a narrowing in bid‐ask spreads, and is contrary to intraday patterns documented for specialist markets. The authors conclude that the increase in depth and narrowing of bid‐ask spreads at the close is driven by dealers rebalancing inventories to achieve target inventory levels in a competitive market. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:294–307, 2008     

Trading Mechanisms and Market Quality: Call Markets versus Continuous Auction Markets

On July 29, 2002, the trading mechanism in the Taiwan Futures Exchange (TAIFEX) was switched from an exclusive call market to a continuous auction market. Based upon several proxies of market quality, in the present study, we set out to empirically examine whether this switch has resulted in any significant improvement in market quality within the TAIFEX. We find that while the quoted spreads, effective spreads, and price volatility are all smaller in the continuous auction market, the call auction market exhibits greater market depth and smaller pricing errors; the latter is also found to be more effective in resolving the problem of information asymmetry. Overall, the results of the present study suggest that the choice between call and continuous auction trading mechanisms essentially involves trade‐offs between the bid‐ask spread, market depth, price volatility, information asymmetry costs, and price efficiency.     

Volume and Volatility Surrounding Quarterly Redesignation of the Lead S&P 500 Futures Contract

During the last weeks before each quarterly expiration of Standard & Poor's (S&P) 500 futures, the bulk of trading volume begins to shift away from the next‐to‐expire (nearby or lead) contract toward the second‐to‐expire (next out) contract. At some point, the exchange formally redesignates the next out as the new lead contract, and the next out replaces the nearby in the futures pit location designated for the lead contract. This event invariably results in a dramatic increase (decrease) in trading activity in the next out (nearby) contract. This shift in relative trading volumes is due to the microstructure of the futures exchange rather than new information or underlying volatility conditions. The event thus offers us an opportunity to examine how volatility responds to noninformation‐based exogenous changes in volume. This study examines the volatility behavior of nearby and next out S&P 500 futures contracts on the 10 days surrounding quarterly redesignation of the lead contract. Our model measures possible changes in (a) the level of volatility and/or (b) the association between volume and volatility after redesignation of the lead contract. Results indicate that when we account for the association between volume and volatility, the higher volume lead contract consistently experiences a lower level of volatility. This outcome supports the view that the larger population of liquidity providers who trade the more active lead contract fosters greater market depth and lower volatility. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21:1119–1149, 2001     

Market microstructure of FT-SE 100 index futures: An intraday empirical analysis

This article examines the market microstructure of the FT-SE Index futures market by analyzing the intraday patterns of bid-ask spreads and trading activity. The patterns are remarkably different from those of stock and options markets because of the futures market's open outcry system with frenzied scalpers/short-term marketmakers. Spreads are stable over the day, but decline sharply at the close and increase when U.S. macroeconomic news is distributed. Traders actively trade at the open with narrow spreads and large trade sizes. Volatility and volume have higher values at the open and close and when U.S. news is released. The overall results suggest that information asymmetry in the index futures market is insignificant, and traders find it easy to control inventory. The results are also broadly consistent with the Grossman and Miller (1988) model that describes liquidity as the price of transaction demand for immediacy. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 31–58, 1999     

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 Intraday Pattern of Information Asymmetry,Spread, and Depth: Evidence from the NYSE

Studies suggest that investment flows, liquidity imbalances, and institutional trading may create intraday trading patterns and opportunities for investors to time their trades to reduce transaction costs. Motivated by these studies, we divide each trading day into 13 half‐hour trading intervals and measure information asymmetry from price changes, trade sizes, and trade directions. We find that information asymmetry starts high in the morning, drops continuously until it reaches a midday low during Interval 7, rises to a midday high during Interval 10, and drops continuously after. In contrast, neither the spread nor the depth exhibit similar midday extreme values. Essentially, we identify a 90‐min window in the afternoon when net valuable information arrives to the market in high frequency while liquidity is stable, and that may be an opportunity for some investors to time their trades. In addition, we show that market makers employ dynamic strategies that change the spread, the depth, or both to manage information asymmetry. This is particularly evident during the last three trading intervals, where the significant drop in information asymmetry is countered primarily by a significant increase in the depth while the spread is almost constant.     

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.     

Benchmarks in the spotlight: The impact on exchange traded markets

The Fix for precious metals is a global pricing benchmark that provides pricing and liquidity provision for market participants. We exploit the gradual change in the century old auction process to quantify the efficiencies related to more transparent pricing. Our focus is in the market impact of this change on exchange listed products. We find that reforms to the Fix have reduced quoted and effective bid-ask spreads and improved overall market depth. The results imply a positive spillover effect stemming from timelier and more accurate pricing information. The conditions under which we observe the benefits from transparency are related to product liquidity and the degree of market segmentation.     

Cash trading and index futures price volatility

This study examines the effect of cash market liquidity on the volatility of stock index futures. Two facets of cash market liquidity are considered: (1) the level of liquidity trading proxied by the expected New York Stock Exchange (NYSE) trading volume and (2) the noise composition of trading proxied by the average NYSE trading commission cost. Under the framework of spline–GARCH with a liquidity component, both the quarterly average commission cost and the quarterly expected NYSE volume are negatively associated with the ex ante daily volatility of S&P 500 and NYSE composite index futures. Conversely, liquidity and noise trading in the cash market both dampen futures price volatility, ceteris paribus. This negative association between secular cash trading liquidity and daily futures price volatility is amplified during times of market crisis. These results retain statistical significance and materiality after controlling for bid–ask bounce of futures prices and volume of traded futures contracts. This study establishes empirical evidence to affirm the conventional prediction of a liquidity–volatility relationship: the liquidity effect is secular and persistent across markets. © 2010 Wiley Periodicals, Inc. Jrl Fut Mark 31:465–486, 2011     

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     

Sentiment-dependent impact of funding liquidity shocks on futures market liquidity

We examine the effect of funding liquidity changes on futures market liquidity, depending on economic sentiment. Futures market liquidity improves following negative funding liquidity shocks, and economic sentiment is an important determinant explaining this relationship. While individuals' trading is most significantly affected by sentiment, its response to funding liquidity shocks remains independent of sentiment effects. Domestic institutions' reactions depend on the sentiment regime; they trade futures contracts more actively as funding liquidity becomes more abundant (scarcer) when sentiment is more pessimistic (optimistic). Foreigners, following negative funding liquidity shocks, generally increase their futures trading, whereas their trading decreases under the extremely pessimistic sentiment. Domestic banks and pension funds provide liquidity to the futures market even when sentiment is pessimistic.     

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.     

The Relation Between Market Liquidity and Anonymity in the Presence of Tick Size Constraints

In February 2004, the Sydney Futures Exchange removed broker identifiers from the electronic limit order book for interest rate futures contracts, with the stated objective of maintaining transparency and improving market participation and liquidity. We show how the Exchange's aims were generally met by documenting an increase in volume and frequency of trades and a decline in time‐weighted quoted spreads. Although daily effective spreads do not decline, intraday analysis demonstrates that there are improvements in effective spreads which are concentrated to those points in time where the bid–ask spread is not constrained by the size of the minimum tick, and where information asymmetries are present. © 2012 Wiley Periodicals, Inc. Jrl Fut Mark 34:56–73, 2014     

Long‐term information,short‐lived securities

The authors explore strategic trade in short‐lived securities by agents who have private information that is potentially long‐term, but do not know how long their information will remain private. Trading short‐lived securities is profitable only if enough of the private information becomes public prior to contract expiration; otherwise the security will worthlessly expire. How this results in trading behavior fundamentally different from that observed in standard models of informed trading in equity is highlighted. Specifically, it is shown that informed speculators are more reluctant to trade shorter‐term securities too far in advance of when their information will necessarily be made public, and that existing positions in a shorter‐term security make future purchases more attractive. Because informed speculators prefer longer‐term securities, this can make trading shorter‐term contracts more attractive for liquidity traders. The conditions are characterized under which liquidity traders choose to incur extra costs to roll over short‐term positions rather than trade in distant contracts, providing an explanation for why most longer‐term derivative security markets have little liquidity and large bid‐ask spreads. © 2006 Wiley Periodicals, Inc. Jrl Fut Mark 26:465–502, 2006     

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     

Impact of Liquidity on the Futures‐Cash Basis: Evidence from the Indian Market

Arbitragers’ activities are constrained by market liquidity. In turn, arbitrage activity may trigger order imbalances adversely affecting liquidity. We examine this issue by analyzing the link between the futures‐cash basis and bid–ask spreads using intraday data on single stock futures (SSFs) contracts on Indian stocks. In contrast to other countries, the SSF market in India is very active due to retail investors’ prior experience with the badla system, a form of forward markets. The analysis reveals two‐way Granger causality between the basis and spreads in both the futures and cash markets. Evidence for spreads Granger‐causing basis is stronger for stocks with higher volume and SSFs that are relatively more active than underlying stocks. © 2012 Wiley Periodicals, Inc. Jrl Fut Mark 33:266–298, 2013     

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     

Market openness and market quality in gold markets

This paper studies the impact of market openness on market quality in gold markets, by investigating the openness event that occurred when the Shanghai Gold Exchange (SGE) launched an international board (SGEI) for foreign investors in China. Investors prefer to trade on the SGE than the SGEI, probably due to the SGE’s higher liquidity. In addition, using the New York Mercantile Exchange (COMEX) gold futures as the benchmark, we show the SGE experiences a significant increase in liquidity without a concomitant increase in volatility. Moreover, the SGE’s contribution to international gold price discovery increases after the openness event.     

Decimalization,trading costs,and information transmission between ETFs and index futures

The impact of changes in trading costs, due to decimalization, on informed trading and speed of information transmission between exchange‐traded funds (ETFs) and their corresponding index futures is examined. ETFs began to trade in decimals on January 29, 2001, and index futures continued to trade in their original tick sizes. The focus is on whether the decrease in the minimum tick size of ETFs influences the relative performances of these two types of index instruments in the price‐discovery process. It is found that for ETFs, the trading activity increases, but the market depth drops significantly after decimalization. The spreads for ETFs generally decrease, but the adverse selection component of ETF spreads increases. Furthermore, after decimalization, ETFs start to lead index futures in the price‐discovery process and its share of information also increases. Although index futures still assume a dominant role in information discovery, the information content of the ETFs' prices improves significantly after decimalization. © 2006 Wiley Periodicals, Inc. Jrl Fut Mark 26:131–151, 2006