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Volatility and liquidity in futures markets

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  • Peter R. Locke
  • Asani Sarkar

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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File URL: http://www.newyorkfed.org/research/staff_reports/research_papers/9612.html
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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Research Paper with number 9612.

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Date of creation: 1996
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Handle: RePEc:fip:fednrp:9612

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Related research

Keywords: Futures ; Liquidity (Economics);

References

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  1. 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 937-53, September.
  2. Grossman, Sanford J & Miller, Merton H, 1988. " Liquidity and Market Structure," Journal of Finance, American Finance Association, vol. 43(3), pages 617-37, July.
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Cited by:
  1. Hun Y. Park & Asani Sarkar & Lifan Wu, 1998. "Do Brokers Misallocate Customer Trades? Evidence From Futures Markets," Finance 9801002, EconWPA.
  2. Peter R. Locke & Asani Sarkar & Lifan Wu, 1997. "Market liquidity and trader welfare in multiple dealer markets: evidence from dual trading restrictions," Research Paper 9721, Federal Reserve Bank of New York.

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