| Summary: | 碩士 === 國立臺灣大學 === 財務金融學研究所 === 89 === This paper examines the effects of futures trading on the liquidity and volatility of the cash market. The main analysis is carried out for a stock market, but our results apply to other asset markets as well. We consider a continuous time stock market where liquidity suppliers and demanders may change their stock-trading strategies when futures trading becomes available. Without market makers, the stock market liquidity is supplied by risk-averse investors who submit limit orders and demand risk premia. Correspondingly, there are two classes of liquidity demanders, the rational hedgers who trade either to diversify portfolio risks or to smooth life-time consumption and the irrational speculators who mistakenly take noise as information.
We find that the effects of the futures market on the stock market depend on two main factors: the correlation between liquidity trades in two markets and the composition of the liquidity demanders in the stock market. First, if the liquidity trades are highly negatively (positively or slightly negatively) correlated, opening the futures market improves (reduces) the stock market liquidity and reduces (raises) the volatility, but it also reduces (enhances) the liquidity suppliers’ welfare. Second, mean-reversion in the liquidity demand is shown to improve the liquidity of the stock market. Finally, when there are noise traders, opening the futures market may encourage the latter to trade more aggressively, thereby reducing the stock market liquidity and increasing the volatility and the liquidity suppliers’ welfare.
A modified version of the above model is used to study the effects of futures trading on foreign exchange markets and to obtain useful insights for the optimal trading strategies of discretionary rational hedgers. It is suggested that discretionary hedgers should refrain themselves from trading in a period of time where either important public information may arrive or there is a high uncertainty concerning international arbitrageurs’ trading strategies. Rational hedgers should also avoid entering the market at the same time. Finally, it is a good idea to trade in a period of time when there is only short-lived private information.
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