London International Financial Futures Exchange Research Articles

Asymmetries, causality and correlation between FTSE100 spot and futures: A DCC-TGARCH-M analysis

We use DCC-TGARCH-M to study asymmetries in the conditional variance in FTSE100 spot and futures returns before and after cost-reducing market microstructure changes on the London Stock Exchange and the London International Financial Futures Exchange. We find bidirectional causality-in-mean and that negative shocks have a larger impact on the conditional variances than positive shocks. There is little evidence of causality-in-variance. The results support a risk premium explanation of asymmetric volatility before the microstructure changes; afterwards, there is evidence of a risk premium effect in futures but a momentum effect in spot. Following the microstructure changes, the speed at which the markets absorbed news increased, as did the asymmetric volatility effect of bad news. We also document regular temporary declines in the conditional correlations following contract expiration. This is consistent with the increased uncertainty following expiration, when investors' attention switches to the next near contract, and the no-arbitrage linkage between spot and futures is temporarily reduced.

Price Clustering in Individual Equity Options: Moneyness, Maturity, and Price Level

Equity options have a significant influence on the price discovery process. This study presents unique evidence of substantial price clustering in individual equity options contracts. A particular contribution arises from investigating competing hypotheses on the roles of moneyness and maturity as determinants of option price clustering. We assert that options price clustering can be decomposed to price level, moneyness, and maturity effects. After controlling for other factors, price clustering has an inverse relation with time‐to‐maturity. This supports the negotiation hypothesis, but not the price resolution hypothesis. Price clustering also tends to be inversely related to moneyness. This effect is linked to the intrinsic value component of option price. Both the maturity and moneyness effects act in an opposite direction to what would be anticipated on the basis of price level alone; hence, these two effects are identified as additional influences on option price clustering. It is also found that the designated market maker scheme at NYSE Euronext London International Financial Futures Exchange (LIFFE) has little influence on trade price clustering. © 2012 Wiley Periodicals, Inc. Jrl Fut Mark 33:55–76, 2013

Evaluation of Hedging Techniques as Instruments to Minimise the Impact of Transaction and Translation Risks in Global Business Market

The current global economic development has made it possible for corporate executives to operate anywhere they wish over the world. This opportunity, however, depends on the need and strategy of the company concern. Some companies go into the global market in order to exploit an opportunity that has been identified. Others go global as a market expansion strategy. Others may be due to the fact that the company has reached the maturity stage in its local market, they would have no choice than to go global in order to be in business.Companies have many choices by which they can go into the global market. They may choose importing and exporting, licensing and franchising and by direct foreign investments (DFI), such as joint ventures, minority and/or majority interest and Greenfield operations.Whichever forms the foreign operations take, the local company would be exposed to foreign currency exchange risks. To reduce these risks, the company can make use of natural hedging or using other technical hedging instruments. By natural hedging, the company can choose to bill their foreign customers in the home currency. On the other hand, the multinational company can make use of hedging techniques (derivatives) like spot, forward, futures and options markets. With this strategy, the company can purchase the exchange rate futures or options to purchase some currencies at a future date with the rate set now.Another form of risks faced by the local company in the foreign markets is the country and political risks. The company, however, has the opportunity to design good strategies for handling such risks. Alternatively, the company can take some insurance against some political risks.Though these strategies can help multinational companies to reduce the currency and other risks associated with the foreign operations, they are not complete without obstacles. Trading volume is concentrated in the spot and the forward market than the futures and options and the London International Financial Futures Exchange (LIFFE) and International Monetary Market forms the biggest markets, with the highest volume in the world. Also the volatility of the currency prices in the market as a result of the release of macroeconomic information from the various countries involved in the market.In spite of the drawbacks of the FX market, it remains the best and effective means by which the multinational companies can minimise the FX risks of their international operations.

Placing the ‘post-social’ market: Identity and spatiality in the xeno-economy

Following Knorr Cetina and Bruegger (2002), an understanding of financial markets as ‘post-social’ environments has gained sway. This claim is premised on the idea that new technologies, in particular screen displays of complex real-time financial information, have displaced ‘the market’ from the social and economic relations in which it might otherwise be assumed to be embedded. We argue that recent historical transformations in trading and markets are better characterized as ‘re-spatializations’ involving shifts in the placing and mediation of market spatiality. Material from the City Lives project and other sources is analysed to explore the transformation of the London International Financial Futures Exchange (LIFFE) from the early 1980s onwards. Using the notion of ‘xeno-economy’ (cf. Rotman’s (1987) ‘xeno-money’) it is argued that the spatial redistributions of the market did not so much efface sociality as set up new kinds of relations between local traders and institutions, notably mediated through geographical displaced ‘trading arcades’. The immanence of modes of sociality to markets as intrinsically and necessarily social objects is thereby emphasized.

The informational impact of electronic trading systems on the FTSE 100 stock index and its futures contracts

This article examines the partial adjustment factors of Financial Times Stock Exchange (FTSE) 100 stock index and stock index futures. Using high frequency data from 15 January 1997 to 17 March 2000, it aims to assess the informational impact of the electronic trading systems implemented at the London Stock Exchange and London International Financial Futures Exchange (LIFFE). The results suggest that information runs mainly from the futures market to the spot market. We find that the introduction of stock exchange trading system, in October 1997, has increased the FTSE 100 index's absolute efficiency; however, it reduced the informational feedback to the futures market. The implementation of LIFFE CONNECT at LIFFE, in May 1999, has reduced the absolute and relative efficiency of FTSE 100 futures. These findings seem to imply that during the period under scrutiny electronic trading increased the level of microstructural noise, probably due to the bid–ask bounce and order flow imbalances.

Volatility and Trading Activity Following Changes in the Size of Futures Contracts

This paper examines the relationship between daily price volatility and trading activity one year before and after a change in the size of selected futures contracts. The following three contracts are included in this study: the Stock Price Index traded on the Sydney Futures Exchange (SFE), which had a contract split on October 11, 1993; the FTSE-100 index traded on the London International Financial Futures Exchange (LIFFE), which had a contract split on March 23, 1998; and the 90-Day Bank Acceptance Bill (BAB) traded on the SFE, which had a reverse split on May 1, 1995. We obtain several interesting empirical results. We observe that there is a positive relationship between daily price volatility and the number of trades (trading frequency) before and after a change in the size of the examined futures contracts. We find that the increase (decrease) in total trading frequency has the power to explain the increase (decrease) of daily price volatility after a contract split (reverse split). Most of the average trade size variable has an immaterial impact on price volatility. Decomposing the total trading frequencies into four trade size classes, we find that the trading frequencies for small and large trade size categories are highly significant in explaining changes in daily price volatility after the index futures contracts' splits. These results are consistent with the noise trading hypothesis (Black (1986)) and the hypothesis on less informed trading in index futures markets. For the BAB case, we find that the trading frequencies for small, medium and large sizes impact price volatility before and after the reverse contract split.

Structural Breaks and the Relationship between Barley and Wheat Futures Prices on the London International Financial Futures Exchange

Co-movement between futures prices can arise when commodities are substitutes. Counterintuitively, Dawson and White fail to find a significant long-run link between feed barley and wheat prices on the London International Financial Futures Exchange. This relationship is re-examined using Johansen, Mosconi, and Nielsen's co-integration procedure that permits structural breaks. Results show evidence of co-integration and hence price discovery. There is a significant break in October 2000 following Common Agricultural Policy intervention price reductions, the barley–wheat futures market is perfectly integrated, and the barley price Granger-causes the wheat price. Modeling structural breaks in price relationships appears important.

Multi-market trading in the Eurodollar futures market

On March 18, 2004, the London International Financial Futures and Options Exchange launched trading in Eurodollar futures contracts in an attempt to compete with a U.S. rival, the Chicago Mercantile Exchange. The Chicago Mercantile Exchange responded to the challenge by introducing several policy changes that aided the transfer of its trading volume in Eurodollar futures from open outcry to the electronic trading platform, Globex, thereby retaining its market share. We compare trading volume, effective spread, and price discovery in Eurodollar futures at the Chicago Mercantile Exchange before and after the London International Financial Futures and Options Exchange began trading the same contract. We find a general increase in trading volume on Globex beginning October 2003, way before the London International Financial Futures and Options Exchange launched its contract. Globex provides greater price discovery than open outcry during the entire time period under study. Our research thus supports the global trend of conversion of traditional open outcry systems into electronic exchanges.

A Note on Estimating Market–based Minimum Capital Risk Requirements: A Multivariate GARCH Approach

Internal risk management models of the kind popularized by J. P. Morgan are now used widely by the world’s most sophisticated financial institutions as a means of measuring risk. Using the returns on three of the most popular futures contracts on the London International Financial Futures Exchange, in this paper we investigate the possibility of using multivariate generalized autoregressive conditional heteroscedasticity (GARCH) models for the calculation of minimum capital risk requirements (MCRRs). We propose a method for the estimation of the value at risk of a portfolio based on a multivariate GARCH model. We find that the consideration of the correlation between the contracts can lead to more accurate, and therefore more appropriate, MCRRs compared with the values obtained from a univariate approach to the problem.

Empirical Testing of the Samuelson Hypothesis: An Application to Futures Markets in Australia, Singapore and the UK

In his seminal article, Samuelson (1965) formulated the proposition that futures prices are more volatile the closer a particular contract is to expiry. This paper applies testing procedures for the Samuelson Hypothesis (or maturity effect) to commodity futures contracts on the Sydney Futures Exchange, the London International Financial Futures and Options Exchange and the Singapore International Monetary Exchange. Traditional regression analysis is supplemented by fitting ARCH models to the data and in doing so it is concluded that evidence in favour of the Samuelson hypothesis does exist in a majority of the contracts analysed.

Trading Activity and Intraday Returns in the Interest Rate Futures

This paper studies intraday returns and variations in trading activity in the interest rate futures traded on London International Financial Futures Exchange. The intraday volume exhibits a significant asymmetric response of volume to price changes. This relationship is dynamic as the direction of asymmetry is reversed through out the trading day. Equity markets are known to exhibit an asymmetric effect, although the effect is static. The asymmetric volume-price relationship in equity market is primarily attributed to the short sale constraint, which imparts a positive correlation between volume and signed price changes. The empirical evidence on futures markets suggests that daily volume and price changes are uncorrelated. Since the short sale constraint is absent in futures, an asymmetric volume-return relation in futures has been ruled out. This paper presents evidence on a dynamic asymmetric relation in interest rate futures. The paper also provides an alternative explanation of the dynamic asymmetric relation that arises out of the joint action of scalpers, day traders, and position traders as they formulate their trading strategies.

Erratum

Interdependencies between commodity prices can arise from the impact of changing macroeconomic variables, from complementarities or substitutabilities between commodities, or from common responses by speculators. Malliaris and Urrutia (1996) found significant linkages between rollover prices of six related agricultural commodities on the Chicago Board of Trade. This article examines interdependencies between futures prices for soft commodities traded on the London International Financial Futures Exchange (LIFFE), calculated using Clark indices. Results show that there are no interdependencies between any two prices; price discovery of one contract provides no information about others. © 2002 John Wiley & Sons, Inc. Jrl Fut Mark 22: 269–280, 2002

Interdependencies between agricultural commodity futures prices on the LIFFE

AbstractInterdependencies between commodity prices can arise from the impact of changing macroeconomic variables, from complementarities or substitutabilities between commodities, or from common responses by speculators. Malliaris and Urrutia (1996) found significant linkages between rollover prices of six related agricultural commodities on the Chicago Board of Trade. This article examines interdependencies between futures prices for soft commodities traded on the London International Financial Futures Exchange (LIFFE), calculated using Clark indices. Results show that there are no interdependencies between any two prices; price discovery of one contract provides no information about others. © 2002 John Wiley & Sons, Inc. Jrl Fut Mark 22: 269–280, 2002

Hedging sterling eurobond portfolios: a proposal for eurobond futures contract

Options and futures on government bonds are the only exchange traded derivative contracts currently available to investors wishing to hedge portfolios of eurobonds. This study, forms sterling denominated eurobond portfolios and tests the hedging effectiveness, with respect to these portfolios, of the long gilt futures contract traded on the London International Financial Futures Exchange (LIFFE). Also testing the hedging effectiveness of a futures contract- a Eurobond Index Futures (EIF) contract. Finding the hedging effectiveness of the Long Gilt contract to be inferior to that of the EIF contract. Given the size and importance of the eurobond market, it is therefore believed that it is time to develop purpose built derivative contracts for these capital instruments.

The Determinants of Implied Volatility: A Test Using LIFFE Option Prices

This paper presents and tests a model of the volatility of individual companies’ stocks, using implied volatilities derived from option prices. The data comes from traded options quoted on the London International Financial Futures Exchange. The model relates equity volatilities to corporate earnings announcements, interest‐rate volatility and to four determining variables representing leverage, the degree of fixed‐rate debt, asset duration and cash flow inflation indexation. The model predicts that equity volatility is positively related to duration and leverage and negatively related to the degree of inflation indexation and the proportion of fixed‐rate debt in the capital structure. Empirical results suggest that duration, the proportion of fixed‐rate debt, and leverage are significantly related to implied volatility. Regressions using all four determining variables explain approximately 30% of the cross‐sectional variation in volatility. Time series tests confirm an expected drop in volatility shortly after the earnings announcement and in most cases a positive relationship between the volatility of the stock and the volatility of interest rates.

Optimal Hedging Ratios for Wheat and Barley at the LIFFE: A GARCH Approach

Over 100,000 futures contracts for cereals are traded annually on the London International Financial Futures Exchange. The proportion of the spot position held as futures contracts ‐ the hedging ratio ‐ is critical to traders and traditional estimates, using OLS, are constant over time. In this paper, we estimate time‐varying hedging ratios for wheat and barley contracts using a multivariate generalised autoregressive conditional heteroscedasticity (GARCH) model. Results indicate that GARCH hedging ratios do change through time. Moreover, risk using the GARCH hedge is reduced significantly by around 4 per cent for wheat and 2 per cent for barley relative to the no hedge position, and significantly by around 0.2 per cent relative to the constant hedge. The optimal, expected utility‐maximising, and the risk‐minimising hedging ratios are equivalent.

The Distributional Characteristics of a Selection of Contracts Traded on the London International Financial Futures Exchange

This study examines the distributional properties of futures prices for contracts traded on LIFFE. A filtering process is employed to remove day of the week and holiday effects, a maturity effect, moving average effects and the influence of an asset’s conditional variance from the raw returns series. Alternative distributional models from the stable paretian and ARCH families are examined for their applicability to futures data using a stability under additions. The results conclusively reject the hypothesis that futures returns are normally distributed with findings in favour of two related hypotheses – the mixtures of stable distribution and the ordinary stable distribution.

Pascal spreading of short-term interest rate contracts

This article examines the spreading and pricing of short-term interest rate futures contracts and shows how traditional types of calendar spread positions can emerge as explicit arbitrage solutions. A specific set of intuitive spreading structures, Pascal’s spreading triangle, arises when the underlying daily risk factors are identified as the stochastic coefficients of a high-order polynomial approximation to the yield curve. No empirically estimated hedge ratios are required for these arbitrage strategies. Application of this Pascal spread framework to pricing and trading the London International Financial Futures Exchange (LIFFE) short sterling deposit futures market over the 1989 to 1998 sample period revealed that the LIFFE’s short sterling arbitrage sector’s efficiency improved markedly over time. The improvement over the decade coincided with dramatic declines in futures trading transactions costs. As a byproduct, the framework extracts and measures the quantitative impact of the Y2K millennium-turn pricing distortion on the December 1999 short sterling futures contract. © 2000 John Wiley & Sons, Inc. Jrl Fut Mark 20:889–910, 2000

Backward to the Futures: A Test of Three Futures Markets

Backwardation, first discussed by Keynes (1923), (1930) and Hicks (1946), is a fee paid by a seller of a security to the buyer for the privilege of deferring delivery. It implies that the futures price falls short of the spot price. The reverse case, 'contango', implies that the futures price exceeds the spot price. This paper applies tests for the existence of backwardation to daily closing prices on the Sydney Futures Exchange (SFE), London International Financial Futures Exchange (LIFFE) and the Singapore International Monetary Exchange (SIMEX). We apply a series of tests after Kolb's (1992) US study and find that few of the contracts studied consistently exhibit backwardation.

The liquidity of automated exchanges: new evidence from German Bund futures

Previous literature has suggested that automated exchanges such as the Deutsche Terminborse (DTB) may be less liquid than their open-outcry counterparts such as the London International Financial Futures Exchange (LIFFE), although evidence provided on this issue has been mixed. This paper provides new evidence on the relative magnitudes of bid-ask spreads in the Bund contract traded on the DTB and LIFFE using intraday data from a period in which each exchanges share of total Bund trading was closer than previous research. The findings suggest that quoted bid-ask spreads are wider on the LIFFE than the DTB, even after controlling for their determinants. Furthermore, bid-ask spreads on the DTB increase more rapidly as price volatility increases relative to the LIFFE. Overall, this evidence implies that while automated exchanges are capable of providing more liquidity than floor traded exchanges, the relative performance of automated exchanges deteriorates during periods of higher volatility.