Liquidity-Induced Dynamics in Futures Markets
AbstractFutures contracts on the New York Mercantile Exchange are the most liquid instruments for trading crude oil, which is the world’s most actively traded physical commodity. Under normal market conditions, traders can easily find counterparties for their trades, resulting in an efficient market with virtually no return predictability. Yet even this extremely liquid instrument suffers from liquidity shocks that induce periods of increased volatility and significant return predictability. This paper identifies an important and recurring cause of these shocks: the accumulation of extreme and opposing positions by the two main trader classes in the market, namely hedgers and speculators. As positions become extreme, approaching their historical limits, counterparties for trades become scarce and prices must adjust to induce trade. These liquidity-induced price adjustments are found to be driven by systematic speculative behaviour and are determined to be significant.
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Bibliographic InfoPaper provided by Economics and Econometrics Research Institute (EERI), Brussels in its series EERI Research Paper Series with number EERI_RP_2008_01.
Length: 38 pages
Date of creation: Jan 2008
Date of revision:
Liquidity; Futures Markets; Return Predictability; Volatility; Trader Positions; Directional Realized Volatility; Hedgers; Speculators; Position Bounds;
Other versions of this item:
- G0 - Financial Economics - - General
- G1 - Financial Economics - - General Financial Markets
- C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-10-28 (All new papers)
- NEP-FMK-2008-10-28 (Financial Markets)
- NEP-MST-2008-10-28 (Market Microstructure)
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