The Chicago Board of Trade (CBOT) introduced side by side trading of its agricultural futures commodities in August 2006. We analyze and compare market quality conditions in corn, soybeans, and wheat futures when these contracts trade simultaneously on open outcry and electronic trading venues. We find that volume migrates from floor trading to electronic trading and transaction costs are higher for floor than for screen-based trading. Nonetheless, we observe that both trading venues contribute significantly to price discovery. Given the recent surge in volatility in commodities futures markets, we also investigate activity variables such as volume that can help explain volatility in the two different trading platforms. We find that for agricultural commodities, variables that help describe volatility are not characteristic of the type of trading venue.
On August 1, 2006, the Chicago Board of Trade1 (CBOT) introduced electronic trading of their agricultural futures contracts. Historically traded on the floor, they began to trade electronically with the objective of capturing greater market share and giving existing customers easy access to the trading of these commodities.
The current study investigates and analyzes market quality and volatility conditions in corn, wheat, and soybeans futures contracts between two different trading mechanisms within one exchange, the CBOT. The purpose is twofold. First, we analyze market quality conditions in the aforementioned contracts before and after the introduction of electronic trading in order to compare and contrast market quality between electronic trading and open outcry. Second, we examine the relationship between volume and volatility. Several studies have examined the impact of liquidity variables like volume and open interest on volatility. Bessembinder and Seguin (1993) show that volume and open interest play an important role in explaining volatility behavior when futures contracts are traded in an open outcry setting. Wang and Yau (2000) argue that the volume and volatility variables are endogenously determined and, hence, the analysis of volume-volatility relationship should account for this endogeneity bias. We employ Wang and Yau's framework to investigate the volume–volatility relationship for floor and electronically traded futures contracts.
For over a decade there has been a trend in market migration from traditional open outcry to electronic trading. In some instances both markets have coexisted while in others, open outcry trading has given way to electronic trading. Many authors have studied this phenomenon by analyzing different aspects of the market for a diverse group of financial and metals futures contracts. Examples of such work include, Martinez et al., 2008, Chung & Chiang, 2006, Ates & Wang, 2005a, Bloomfield et al., 2005, Aitken et al., 2004, Copeland et al., 2004, Covrig et al., 2004, Gwilym & Alibo, 2003, Theissen, 2002, Tse & Zabotina, 2001, Blennerhassett & Bowman, 1998, Frino et al., 1998, Martens, 1998 and Pirrong, 1996.
Although previous work provides evidence in support of both electronic and open outcry markets, in practice, we observe a tendency of movement in trading from open outcry to electronic venues. Glosten's (1994) model suggests a tendency of financial markets to consolidate into a single electronic exchange. Current events indicate these predictions are materializing. In December of 2007, the Intercontinental Futures Exchange announced trading of commodities exclusively on its electronic platform heralding the end of floor-trading. By the end of 2008, three well known derivatives exchanges, the Chicago Mercantile Exchange (CME), the CBOT, and the New York Mercantile Exchange (NYMEX), will have merged creating the world's largest derivatives exchange.
The side by side trading of commodities within the same exchange offers an opportunity to analyze market quality conditions for agricultural futures. While similar comparisons have been conducted for financial, metal, and foreign exchange futures,2 to the best of our knowledge, such analyses has not yet been conducted for agricultural commodities. In support of this view, Madhavan (2000) warns us about the one-size-fits-all regulation and policy approaches. What has worked in other futures markets may not be the standard for agricultural commodities markets. In addition, floor and electronic trading within the same exchange provides a cleaner setting by avoiding any market quality differences that exist between exchanges.
We believe the results from this study will help policymakers better understand trading venue characteristics and information that cultivate the best market quality conditions for the trading of agricultural commodities such as corn, wheat, and soybeans.
On August 1, 2006, the CBOT launched the side by side trading of
its agricultural futures contracts. We analyze the market quality
conditions of floor and electronically traded corn, soybeans, and
wheat futures contracts. To begin with we find that volume quickly
migrates from floor to electronic venue. In addition, trading costs, as
proxied by effective spreads, widen on the floor and are smaller for
screen trading. The price discovery analysis indicates that new
information is rapidly incorporated in prices in both trading venues
although electronic markets appear to reflect it more quickly. Overall
there appears to be a transition in market quality from floor to
electronic venues.
Our results show the migration of market quality from floor to
electronic markets and thus support the current trend in shifting
trading volume from open outcry to electronic trading venues. Even
so, we observe that in the case of agricultural commodities, the
activity variables that affect the price volatility on the floor also affect
the price volatility on the electronic venue. Our results may help
policymakers identify the type of market that offers the best trading
conditions as well as the sources of volatility for agricultural
commodities futures.
