The components of the bid‐ask spread: Evidence from the corn futures market

Abstract

This article examines whether USDA announcements and commodity index fund rolling activity have an impact on liquidity costs, measured by the bid-ask spread. Using Huang and Stoll's (1997) model of liquidity costs, we estimate whether changes to liquidity costs are driven by its adverse selection, inventory, or order processing components. Commodity index fund roll activity reduces the asymmetric information cost component of liquidity cost due to an increased proportion of noninformation-based trading, but the inventory cost component increases as (mostly long only) commodity index funds sell their nearby positions and buy the first deferred contract-raising liquidity providers' risk of building a position. The sum of these two effects is that liquidity costs remain low during index fund roll periods, averaging one "tick" (0.25 cents). On USDA report release days, we find that informed traders raise the asymmetric information component of liquidity costs in the first hour after release, but the inventory cost component is reduced due to the increase in volume. Similar to index fund roll activity, liquidity costs on USDA report release days remain low, averaging one "tick". Our findings that liquidity costs are minimally changed during USDA report releases and commodity index fund roll periods is consistent with other recent research on liquidity costs, but we show that what drives liquidity costs differs substantially depending on the circumstances surrounding daily trading.JEL classifications: Q13, G12, G14, D23

Measuring price discovery between nearby and deferred contracts in storable and nonstorable commodity futures markets

“…However, the magnitude and significance of the parameter decreases from 3.9% in the first contract pair to 3.6% in the second contract pair and becomes insignificant in the third and fourth contract pairs. Several studies have documented a “sunshine trading effect,” which consists of a predetermined commodity index roll period attracting counterparties and increasing liquidity supply (Shang, Mallory, & Garcia, 2018). Since traders are highly concentrated in the nearby contract during index rolling periods (Aulerich, Irwin, & Garcia, 2014), one possible explanation for the positive correlation between index rolling and PS could be that liquidity improvement caused by the “sunshine trading effect” is more pronounced in nearby contracts than deferred contracts.…”

Looking under the surface: An analysis of iceberg orders in the U.S. agricultural futures markets

“…Shang et al. (2018) show that market volatility and BAS are relatively high during the market open, a period when the volume is usually elevated, and the risk to liquidity providers due to adverse selection is high. Similar to findings in the literature, we find increased trading volume, volatility, and relative spread during market opening and closing.…”

“…Existing studies have also identified that market conditions vary during trading hours. For example, trading activity and volatility are generally higher during market opening and closing than during mid‐day hours (Joseph & Garcia, 2018; Shang et al., 2018), which is likely to affect market quality. To capture these intraday patterns, we introduce dummy variables for the first (last) 30 minutes of market opening (closing), ().…”

Surprise and dispersion: informational impact of USDA announcements

“…On each trading day, about 10–20 maturities are traded with different levels of activity. We focus on the nearby contracts as they are the most liquid, which should allow for a more accurate assessment of the market response to USDA announcements (Isengildina‐Massa et al., ; Karali, ; Shang et al., ). Each contract is rolled over to the second‐nearby contract when the volume of the second‐nearby contract exceeds the volume of the front‐end contract.…”

“…Shang et al. () focus on the impact of commodity index fund roll activity and USDA announcements on liquidity costs on the day following the announcement.…”