1. Futures trading and market microstructure of the underlying security: A high frequency experiment at the single stock futures level Kate Phylaktis and Gikas Manalis Discussion by Alfonso Dufour EMG/ESRC Workshop, Cass Business School

2. May 09 © A. Dufour, 2009 2 Objective To study how the introduction of single stock futures affects the quality of the underlying spot market using high frequency data –Spread –Depth –Information asymmetry –Volatility –Volume Previous studies compare pre- and post- futures listing with lower frequency data and use event- study methodologies.

3. May 09 © A. Dufour, 2009 3 Motivations Policy implications Information revelation and price discovery Market integrity and manipulation Traders believe: 1999’s introduction of futures market slowed down the cash market

4. May 09 © A. Dufour, 2009 4 Predictions Jones, Kaul and Lipson (1994) Non-trading periods: –periods when exchanges are open –traders endogenously choose not to trade and quotes are available Trading and non-trading periods are similar because : –Non-trading periods are not predictable, the information- gathering and trading activities are not affected by their ability to trade –Both are open markets so production and release of public information is potentially the same –Informed trader may move to the more liquid futures market reducing the asymmetric information risk in the spot market. –Easier hedging reduces inventory costs in the spot market Asymmetric information is the same for trading and non-trading periods. Private information does not play a significant role in driving price dynamics but public information seems the primary determinant of volatility.

5. May 09 © A. Dufour, 2009 5 More Predictions Pan & Poteshman (2003) argue: “derivative markets may play a dominant role in the transmission of information for stocks with less efficient information flow”

6. May 09 © A. Dufour, 2009 6 Results Futures trading frequency is significantly lower than spot trading frequency When futures trade 1.Spot bid-ask spread and depth decrease –Reduction in the informational asymmetry does not explain this decrease 2.Volatility and volume of the spot market increase. –consistent with the idea that institutional traders take simultaneous positions in both the futures and the underlying market Evidence does not support the view that spot market quality increases with the introduction of futures trading

7. May 09 © A. Dufour, 2009 7 Methodology Single stock futures were introduced in Greece from August 1999. 11 futures contracts. 6 of these futures were introduced in 2004 and the sample period corresponds to the first months of trading. For the other futures the sample period starts more than 2 years after the introduction of the contract. –This may lead to different trading dynamics between the two group of contracts The trading day is split into 1 minute periods. Periods with no trading are classified as non-trading periods. –How sensitive are the results to the definition of 1 minute periods? With longer periods we would have a lower number of non-trading intervals.

8. May 09 © A. Dufour, 2009 8 Some Comments Account for diurnal periodic effects Describe the microstructure of the two markets: –Are the markets electronic order books? Are there market makers with market making obligations? –Any difference in the market structure may be important for the interpretation of the empirical results. –Is trading in the spot market concentrated ? (for example see Anderson (1990)) –In commodity markets, spot market power discourages other traders’ participation (and hedging) and allows the spot monopolist to trade strategically in order to manipulate spot prices and make his futures positions more profitable (Muermann and Shore (2005); Kumar and Seppi (1992); Spiegel and Subrahmanyam (1992)). Do quotes change even with no trading? –Otherwise, when there is no trading cash volatility and volume are both zero

9. May 09 © A. Dufour, 2009 9 More Comments Compare results to the ones obtained by –JKL (1994) asymmetric information is a small proportion of quoted spread (between 12% and 15%) –In this paper asymmetric information 2|M t+30min - M t |/M t is computed as a proportion of mid-quote prices, M t –Shastri, Ramabhadran and Zutter (2008) Table 1. What is the market cap of the sample stocks compared to stocks in the index? This would give a better idea of the size of these companies.

10. May 09 © A. Dufour, 2009 10 Further Comments Some inconsistencies with the literature The quoted depth is lower when futures trade. –If there is lower inventory risk perhaps we would expect a greater depth –Instead perhaps a lower spread and depth could be due to greater price competition and more aggressive pricing which is also compatible with larger volume and volatility. Usually, in time series analyses larger volumes are associated to larger spreads and to greater likelihood of informed trading.

11. May 09 © A. Dufour, 2009 11 References Anderson, Ronald W., 1990, Futures Trading for Imperfect Cash Markets: A Survey, in Commodity, Futures and Financial Markets, ed. L. Phlips, Kluwer Academic Publishers, Dordrecht, Netherlands (literature review on futures trading when the underlying market is imperfectly competitive) Kumar, Praveen and Duane J. Seppi, 1992, Futures Manipulation with “Cash Settlement”, Journal of Finance, Vol. 47(4), pp. 1485-1502 Muermann and Shore (2005) Wharton working paper Spiegel, Matthew and Avanidhar Subrahmanyam, 1992, Informed Speculation and Hedging in a Non-competitive Securities Market, Review of Financial Studies, Vol. 5(2), pp. 307-329.