Liquidity and the Evolution of Price Discovery on Floor versus Screen-Based Trading Systems: An Analysis of the Foreign Exchange Futures Markets

Abstract

This paper examines the relative liquidity and rate of price discovery on floor-based versus screen-based trading systems in the Japanese Yen, British Pound, and Euro foreign exchange futures markets traded on the Chicago Mercantile Exchange (CME). Intra-day data from January 2, 2003 through March 5, 2004 are used in our analysis. We find that liquidity, measured by bid-ask spreads, is tighter in the automated trading system before and after controlling for such variables as price volatility and trading volume. For trading that occurred during the earlier part of the sample period, i.e., calendar year 2003, floor-based trading typically contributed more to price discovery in the Japanese Yen and British Pound markets. However, in the latter part of the sample period, i.e., calendar year 2004, screen trading took the dominant role and contributed more to price discovery in these same markets. Automated trading dominated price discovery in the Euro foreign exchange futures market during the entire 2003-2004 sample period. The results of our regression analysis support the hypothesis that relative liquidity and operational efficiency jointly influence the contribution shares in the price discovery process.