Liquidity of Futures Markets: Dynamics and Risk Premium

Mark Refermat, PhD
Liquidity risk, futures markets, commodity futures, asset classes

Abstract :

Liquidity in futures markets across asset classes: Futures offer a unique lens to analyze cross-market and asset class liquidity dynamics due to their broad market and asset class representation and comparability. This analysis is to use futures markets to understand liquidity commonality and idiosyncrasy inter and intra asset class and to examine if liquidity shocks are related and have spillover effects. Using Amihud (2002) and Fong et al. (2010) liquidity proxies, the evidence suggests high commonality within each asset class and persistence through time. The results highlight that asset class’s liquidity shocks are related to other asset classes. Liquidity in every asset class is related to market and funding liquidity conditions, which expands the existing literature.

Is liquidity in futures markets priced? Less liquid assets should be compensated given the increased risk they have because they not only are more costly to trade, but also have prices that tend to suffer during periods of market stress. Previous studies show liquidity risk premium does exist in the equity markets. This study tries to understand if the liquidity premium also exists in the futures market and if liquidity risk is priced across a range of global futures covering multiple asset classes and can be added to growing range of global multiple asset class factors. Liquidity is a multifaceted concept thus the investigation demands a multi pronged approach. Using market accepted liquidity measures, namely Amihud (2002) and Fong et al. (2010), I explore a multitude of dimensions of liquidity and observe pricing power of the futures markets across equities, fixed income, currencies, and commodities. I find evidence that the relative level of liquidity is being priced across futures markets using Amihud (2002), which captures price impact of order flow, by creating a liquidity factor based on sorted portfolios using this measure. This liquidity factor is not spanned by market and other known multi asset class factors nor other known market liquidity data. However by creating a factor based on transaction cost using the Fong et al. (2010) there is evidence that it is already explained by existing factors and is not additive to help explain returns.

Publication date of the thesis

Thesis committee

Supervisor: Nikolaos Tessaromatis, EDHEC Business School

External reviewer: Joëlle Miffre, Audencia Business School

Other committee member: Raman Uppal, EDHEC Business School