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The Quality of Price Discovery and the Transition to Electronic Trade: The Case of Cotton Futures

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  • Janzen, Joseph P.
  • Smith, Aaron D.
  • Carter, Colin A.

Abstract

This paper studies the effect of electronic trade on the quality of market price discovery, using the Intercontinental Exchange (ICE) cotton futures market as a laboratory to measure market quality under periods of floor trade, parallel floor and electronic trade, and electronic-only trade. Using random-walk decomposition methods pioneered by Hasbrouck (2007), we decompose intraday variation in cotton prices into two components: one related to information about market fundamentals and one a “pricing error” related to market frictions such as the cost of liquidity provision and the transient response of prices to trades. We describe the properties of this pricing error to characterize market quality under both floor and electronic trading systems. Unlike previous studies, we analyze more than the average magnitude of the pricing error. Each day, we calculate statistics that describe market quality on that day, and we study their trend, variance and persistence.

Suggested Citation

  • Janzen, Joseph P. & Smith, Aaron D. & Carter, Colin A., 2012. "The Quality of Price Discovery and the Transition to Electronic Trade: The Case of Cotton Futures," 2012 Annual Meeting, August 12-14, 2012, Seattle, Washington 125024, Agricultural and Applied Economics Association.
    • Handle: RePEc:ags:aaea12:125024
    DOI: 10.22004/ag.econ.125024
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    References listed on IDEAS

    as
    1. Franke, Gunter & Hess, Dieter, 2000. "Information diffusion in electronic and floor trading," Journal of Empirical Finance, Elsevier, vol. 7(5), pages 455-478, December.
    2. Hasbrouck, Joel, 1993. "Assessing the Quality of a Security Market: A New Approach to Transaction-Cost Measurement," The Review of Financial Studies, Society for Financial Studies, vol. 6(1), pages 191-212.
    3. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March.
    4. Julieta Frank & Philip Garcia, 2010. "Bid-Ask Spreads, Volume, and Volatility: Evidence from Livestock Markets," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 93(1), pages 209-225.
    5. Martinez, Valeria & Gupta, Paramita & Tse, Yiuman & Kittiakarasakun, Jullavut, 2011. "Electronic versus open outcry trading in agricultural commodities futures markets," Review of Financial Economics, Elsevier, vol. 20(1), pages 28-36, January.
    6. Thompson, S. & Waller, M.L., 1988. "Determinants Of Liquidity Costs In Commodity Furures Markets," Papers 172, Columbia - Center for Futures Markets.
    7. Lee, Charles M C & Ready, Mark J, 1991. "Inferring Trade Direction from Intraday Data," Journal of Finance, American Finance Association, vol. 46(2), pages 733-746, June.
    8. Henry Bryant & Michael Haigh, 2004. "Bid-ask spreads in commodity futures markets," Applied Financial Economics, Taylor & Francis Journals, vol. 14(13), pages 923-936.
    9. Joshua D. Coval & Tyler Shumway, 2001. "Is Sound Just Noise?," Journal of Finance, American Finance Association, vol. 56(5), pages 1887-1910, October.
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    Cited by:

    1. Joseph P. Janzen & Michael K. Adjemian, 2017. "Estimating the Location of World Wheat Price Discovery," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 99(5), pages 1188-1207.
    2. Janzen, Joseph P. & Adjemian, Michael K., 2016. "Estimating the Location of World Wheat Price Determination," 2016 Annual Meeting, July 31-August 2, Boston, Massachusetts 235838, Agricultural and Applied Economics Association.

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    More about this item

    Keywords

    Crop Production/Industries; Research and Development/Tech Change/Emerging Technologies;

    JEL classification:

    • Q0 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - General

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