Concentration and Liquidity in Mature Markets: Evidence from the US Dollar/Yen Futures Market

The cost of liquidity is the major cost of transacting on organised futures exchanges. Liquidity has value both to traders and to exchanges. This paper argues that liquidity varies directly with market development, and that this relationship provides a major incentive for mergers among exchanges. While previous research on liquidity has focused on spot markets for a range of securities, this paper employs data from the US dollar/Yen futures contract to investigate the relationship between liquidity and volume, between liquidity, volume and volatility, and between liquidity and the speculation ratio. The paper tests for non–linearity in these relationships, and explores the presence of Granger causality between pairs of key variables.
The results include inter alia the presence of a significant negative relationship between the cost of liquidity and volume, and evidence of a significant non–linear relationship in which the cost of liquidity varies directly with volatility and negatively with the conditional fourth moment about the mean of daily prices (a measure of kurtosis). Moreover, there is evidence that liquidity Granger causes volume, that volatility Granger causes volume, and that liquidity Granger causes the speculation ratio.