Liquidity in the Futures Pits: Inferring Market Dynamics from Incomplete Data

All errors are my own responsibility. Abstract Motivated by economic models of sequential trade, empirical analyses of market dynamics in the U.S. equities market frequently estimate liquidity from regressions of price changes on transaction volumes, where the latter are signed (positive for buyer-initiated trades; negative for seller-initiated trades). This paper estimates these specifications for transaction data from pit trading at the Chicago Mercantile Exchange. To deal with the absence of timely bid and ask quotes (generally used to sign trades in the equity market studies), this paper proposes new techniques based on Markov chain Monte Carlo estimation. As in the corresponding equity market specifications, the model structure implies a decomposition for long-run price volatility into trade-and non-trade-related components. For the S&P contract, trades have a negligible contribution to volatility. Trades in the pork belly contract account for twenty percent of the (long-term) price volatility. Trades in the DM contract account for forty percent of the volatility. This last finding may indicate that although the futures market in the DM is dwarfed in volume by the interbank spot/forward market, the latter's relative lack of transparency causes significant price discover to occur in the futures market.