From pit to electronic trading: Impact on price volatility of U.S. Treasury futures

• Author: Lucjan T. Orlowski
• DOI: http://doi.org/10.1016/j.rfe.2015.02.001
• Published date: 01 April 2015
• Date: 01 April 2015

From pit to electronic trading: Impact on price volatility

of U.S. Treasury futures

Lucjan T. Orlowski

Economicsand InternationalFinance, Sacred Heart University,5151 Park Avenue,Fairfield, CT 06825, USA

abstractarticle info

Availableonline 18 February 2015

JEL classification:

E44

G12

G13

Keywords:

Pit trading

Electronicfutures trading

10-yearTreasury futures

Futuresprice volatility

This paperinvestigates the dynamicsof price volatility and tradingvolume of 10-year U.S. Treasurynote futures

within the context of transition from pit to electronic trading. The analysisis conducted over four discernible

phases of futurestrading evolution: thepit-only phase, the leap to electronictrading, and the electronictrading

dominantphase, which is dividedfurther into two periods,the before and after the financialcrisis of 2007/2009.

Generalized autoregressiveconditional heteroskedasticity with in-mean conditional varianceand generalized

error distributionparameterization (GARCH-M-GED) tests areconducted to examine the conditional volatility

of totalreturns index asa functionof trading volume.The empirical resultsshow a consistentlynegative relation-

ship between the trading volume and price volatility for all four analyzed phases. They also show decreasing

leptokurtosis (except for the direct effects of the recent crisis), continuously high persistency in volatility, as

well as a weakeningimpact of unexpected ARCH-type shocksduring the most recent analyzed period.Overall,

the shift to electronic trading entails a substantialincrease in trading volume,but not in pricevolatilityof Treasury

futures.

© 2015 ElsevierInc. All rights reserved.

1. Introduction

Financial markets for trading f utures on U.S. Treasury notes and

bonds have undergone major institutional evolution since they were

first introduced in the 1970s. One of the critical innovations has been

the transition from the open-outcry pit trading to electronic trading.

This major institutionalchange affected the price discovery processin

several critical ways. First, it allo wed for extending the trading time

from the U.S. business hours to a round- the-clock 24-hour period.

Second, the process of matchingbuyers and sellers moved away from

the hand signals used by pit traders to lightning-fast electronic trade

matching algorithms. Besides enhancing the speed and the efficiency

of price discovery, the shift to elect ronic trading is credited with

reduced transaction costs. All of this occurred during a long, secular

bull marketfor U.S. Treasuries.More recently, the globalfinancial crisis

of 2007/2009 brought about further institutional changes to futures mar-

kets, namelynew regulatory legislation inthe form of the Dodd–Frank

Act. In addition, the crisis induced a considerably increased buying

activity of long-term U.S. Treasury securities by the Federal Reserve.

Recognizingthese changes,this study aims to examine theimpact of

the transitionfrom pit to electronic trading on thenature and patterns

of price volatilityand trading volumeof 10-year Treasury note (T-note)

futures.The main investigative questionis whether price volatilitywas

affected by the massive increase in trading volume that has occurred

with the introduction of the electronic trading. Thisstudy contributes

new dimensions to the literat ure on futures markets by focusing on

the dynamics of price volatility and trading volume in the context of

major institutional change.The general hypothesisis that the transition

from pit to electronic tradinghas improved market liquidity of T-note

futures due to higher trading volume, while price volatility has remained

relatively unaffected.

For the purposeof assessing the impactof the transition, the trading

pattern of 10-year T-note futures is a nalyzed over four discernible

phases. Phase I includes the p it-only trading. It captures th e period

from the beginning of 1982 when 10-year T-note futures were intro-

duced by the ChicagoBoard of Trade (CBOT) to August 28, 2000when

full round-the-clock electr onic was launched.

1

Phase II corresponds

with the fast-track leap to electronic tradi ng, i.e. August 28, 2000 to

September 12, 2003 whena well-defined full electronic trading domi-

nance was reached (defined as a persistent plus-85% shareof 10-year

T-note futureselectronic in total trading). PhasesIII and IV are charac-

terized by the dominance of electronic trading, with the open-outcry

pit trading playing only a margina l role. These last two phases are

separatedbytheonsetofthefinancial crisis.

The empiricaltests are basedon daily data for 10-yearTreasury note

futures madeavailable by the CME Group. The sampleperiod begins in

January 1982 and runs throughthe end of 2011. The data set contains

information for every contract stub (maturity), every trading day, for

open, high, low, and settlement prices,trading volumes in the regular

Reviewof Financial Economics25 (2015) 3–9

E-mailaddress: OrlowskiL@sacredheart.edu.

1

Notably,the after-hours electronic trading wasin place prior to August 2000, but its

sharein the overallmarket activity was minor.

http://dx.doi.org/10.1016/j.rfe.2015.02.001

1058-3300/©2015 Elsevier Inc. All rightsreserved.

Contents listsavailable at ScienceDirect

Review of Financial Economics

journal homepage: www.elsevier.com/locate/rfe