Bid-Ask Spreads, Volume, and Volatility: Evidence from Livestock Markets

Copyright 2009 by Julieta Frank and Philip Garcia. All rights reserved. Readers may make verbatim copies of this document for non‐commercial purposes by any means, provided that this copyright notice appears on all such copies. Abstract Understanding the determinants of liquidity costs in agricultural futures markets is hampered by a need to use proxies for the bid-ask spread which are often biased, and by a failure to account for a jointly determined micro-market structure. We estimate liquidity costs and its determinants for the live cattle and hog futures markets using alternative liquidity cost estimators, intraday prices and micro-market information. Volume and volatility are simultaneously determined and significantly related to the bid-ask spread. Daily volume is negatively related to the spread while volatility and volume per transaction display positive relationships. Electronic trading has a significant competitive effect on liquidity costs, particularly in the live cattle market. Results are sensitive to the bid-ask spread measure, with a modified Bayesian method providing estimates most consistent with expectations and the competitive structure found in these markets. In agricultural futures markets, traders face a variety of transaction costs including brokerage fees, exchange fees, and liquidity costs which influence the effectiveness of marketing decisions. The first two costs are available, but estimation of liquidity costs is challenging, and is often performed using a measure of the bid-ask spread (BAS). Regardless the measure, there is evidence that the liquidity costs change over time and with market conditions. Identifying the factors that influence liquidity costs is of substantial value for participants and decision makers operating in the market. For instance, the cost of placing an order on a lightly traded day may be higher than the same order a few days later if trading activity increases. Hence, understanding the determinants of liquidity costs can help identify cost-reducing opportunities in marketing decisions. Our understanding of the factors that influence liquidity costs in agricultural futures markets is limited for several reasons. In most agricultural markets, liquidity costs are not directly observed and proxies must be used. Also, previous research in agricultural markets generally has been performed for short periods of time, mainly due to data availability and computational complications associated with high frequency intraday data (e.g. Thompson and Waller 1988, Brorsen 1989). These short-term investigations make it difficult to identify the presence of contract and time-to-maturity effects. Further, in light of the increase in electronic trading in agricultural markets, relationships …