An investigation into the role and impact of the volume of trade in UK futures markets

Abstract

In this thesis a detailed examination is carried out into the role and impact of the volume of trade in UK futures markets. While the success of a market may be judged by the number of investors that it attracts, how does the behaviour of individuals influence such key variables as price volatility and the cost of trading? The empirical work carried out here allows a unique appreciation of issues that have important implications for policy makers, investors and the practitioner. Motivated by a desire to understand whether volatility is destabilising or a reflection of fundamental factors, as well as the nature of the distribution of price returns, the relationship between volume and price movements is investigated in detail. The preliminary analysis suggests an important role for the flow of information which is confirmed by the rigorous testing of Anderson's (1996) specification of the Mixture of Distributions Hypothesis. The exploitation of this model allows an in-depth analysis of the information process including the identification of the informed and uninformed components of volume. There is also an investigation into the possibility that the volume statistic itself has an informative value. Using the Blume et al. (1994) approach the results suggest that, for a variety of futures contracts, the markets show a high degree of information dispersion. The need to attract investors has never been more acute than in today's competitive financial environment. It is therefore important to obtain a good appreciation of the relationship between volume and the cost of trading. This thesis includes a comprehensive intra-day study of the relation within a simultaneous econometric framework that exploits state-space models to investigate how markets react to unexpected levels of trading. The results question the dominance of inventory cost models and suggest that patterns of trade have become more predictable since contract inception, despite increases in volume.