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Volatility and liquidity in futures markets

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Abstract

We study the provision of liquidity in futures markets as price volatility changes. For both active and inactive contracts, 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 inactive contracts (where the cost of market making is relatively high), market makers are hurt by volatility, and customers step forward to provide liquidity through standing limit orders.

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  • Peter Locke & Asani Sarkar, 1996. "Volatility and liquidity in futures markets," Research Paper 9612, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednrp:9612
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    References listed on IDEAS

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    1. Grossman, Sanford J & Miller, Merton H, 1988. " Liquidity and Market Structure," Journal of Finance, American Finance Association, vol. 43(3), pages 617-637, July.
    2. Gregory J. Kuserk & Peter R. Locke, 1993. "Scalper behavior in futures markets: An empirical examination," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 13(4), pages 409-431, June.
    3. Silber, William L, 1984. "Marketmaker Behavior in an Auction Market: An Analysis of Scalpers in Futures Markets," Journal of Finance, American Finance Association, vol. 39(4), pages 937-953, September.
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    Cited by:

    1. Locke, Peter R. & Sarkar, Asani & Wu, Lifan, 1999. "Market Liquidity and Trader Welfare in Multiple Dealer Markets: Evidence from Dual Trading Restrictions," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 34(1), pages 57-88, March.
    2. Isita Mukherjee & Bhaskar Goswami, 2017. "The volatility of returns from commodity futures: evidence from India," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 3(1), pages 1-23, December.
    3. Hun Y. Park & Asani Sarkar & Lifan Wu, 1998. "Do Brokers Misallocate Customer Trades? Evidence From Futures Markets," Finance 9801002, University Library of Munich, Germany.

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    Keywords

    Futures; Liquidity (Economics);

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