Sentiment‐dependent impact of funding liquidity shocks on futures market liquidity

Abstract

We examine the effect of funding liquidity changes on futures market liquidity, depending on economic sentiment. Futures market liquidity improves following negative funding liquidity shocks, and economic sentiment is an important determinant explaining this relationship. While individuals' trading is most significantly affected by sentiment, its response to funding liquidity shocks remains independent of sentiment effects. Domestic institutions' reactions depend on the sentiment regime; they trade futures contracts more actively as funding liquidity becomes more abundant (scarcer) when sentiment is more pessimistic (optimistic). Foreigners, following negative funding liquidity shocks, generally increase their futures trading, whereas their trading decreases under the extremely pessimistic sentiment. Domestic banks and pension funds provide liquidity to the futures market even when sentiment is pessimistic.

Who pays the liquidity cost? Central bank announcements and adverse selection

“…Panel A of Table 6 suggests that market liquidity generally deteriorates as domestic institutions' participation increases. The coefficients of Ins are significantly negative across all illiquidity proxies, suggesting that they generally provide liquidity in this market (Hendershott & Riordan, 2013; Ryu & Yu, 2022; Ryu et al, 2022c). On the other hand, the significantly positive coefficients of the interaction terms specifically indicate the bid‐ask spread is wider, inverse depth is steeper, and trading frequency is lower when the central bank announces its base rate decisions.…”

Left‐digit biases: Individual and institutional investors

“…To robustly proxy investors' excess buying and selling, we calculate buy–sell imbalance measures based on trading volume, trading value, and the number of transactions. Moreover, we compute the buy–sell imbalances separately for individual and institutional investors, as they often trade for different motives (Lee et al, 2021; Ryu, 2012; Ryu & Yu, 2022).…”

“…First, we remove the records of futures transactions that are executed on maturity days. Investors trade futures contracts with different motives on maturity days, leading them to exhibit somewhat abnormal trading patterns (Ryu, Webb, et al, 2023; Ryu & Yang, 2020; Ryu & Yu, 2021). Index futures in Korea expire on the second Thursdays of March, June, September, and December; thus, we exclude the observations on 19 maturity days from our sample.…”

Shed old baggage and invest wisely. A bibliometric and thematic analysis of disposition effect and investment

“…However, the studies on the disposition effect in derivative markets are negligible. Behavioral biases and sentiments affect derivative markets (Locke, 2011), options contracts (Li et al , 2021), commodity returns (Simon and Manu, 2021), future market liquidity (Ryu and Yu, 2022) and so it is important to see the presence and effect of disposition effect in derivatives. We suggest exploring the role of the disposition effect in derivatives markets.…”