Cash Trading and Index Futures Price Volatility

The Journal of Futures Markets, Vol. 31, No. 5, 465–486 (2011)

22 Pages Posted: 3 Dec 2013

Date Written: December 2, 2013

Abstract

This study examines the effect of cash market liquidity on the volatility of stock index futures. Two facets of cash market liquidity are considered: (1) the level of liquidity trading proxied by the expected New York Stock Exchange (NYSE) trading volume and (2) the noise composition of trading proxied by the average NYSE trading commission cost. Under the framework of spline – GARCH with a liquidity component, both the quarterly average commission cost and the quarterly expected NYSE volume are negatively associated with the ex ante daily volatility of S&P 500 and NYSE composite index futures. Conversely, liquidity and noise trading in the cash market both dampen futures price volatility, ceteris paribus. This negative association between secular cash trading liquidity and daily futures price volatility is amplified during times of market crisis. These results retain statistical significance and materiality after controlling for bid – ask bounce of futures prices and volume of traded futures contracts. This study establishes empirical evidence to affirm the conventional prediction of a liquidity-volatility relationship: the liquidity effect is secular and persistent across markets.

Suggested Citation

Li, Jinliang, Cash Trading and Index Futures Price Volatility (December 2, 2013). The Journal of Futures Markets, Vol. 31, No. 5, 465–486 (2011), Available at SSRN: https://ssrn.com/abstract=2362263 or http://dx.doi.org/10.2139/ssrn.2362263

Jinliang Li (Contact Author)

Tsinghua University ( email )

1 Tsinghua Yuan
Beijing, 100084
China

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