Empirical investigation of futures markets quality: the role of queue length, information costs, and technological improvements

This dissertation provides an investigation of the impact of improvements in trading technology on the efficiency of financial markets. It is composed of three empirical tests examining the behavior of the process of price discovery, arbitrage incidence, and futures markets liquidity. This thesis illustrates the recent path of market evolution and addresses the gaps in the empirical literature related to the behavior and characteristics of futures markets quality.

First, this dissertation examines the impact of changes in real-time data access fees on price discovery in the crude oil futures market. Specifically, analysis centers on the differences in price discovery in the West Texas Intermediate crude oil futures contracts traded on two exchanges around three events corresponding to changes in real-time data access fees. Additionally, a decrease in price discovery following two events that increase data access costs is documented. These findings are consistent with the theoretical predictions of Cespa and Foucault (2014) that increases in data access costs reduce the number of market participants trading on real-time data and adversely impact price discovery.

Second, an investigation is conducted on the impact of changes in the speed and pricing of direct market access on market efficiency, as measured by frequency, duration, and profitability of arbitrage strategies. To this end, two natural experiments on the EUREX exchange are identified: an exchange-wide improvement in technology reducing message latency, and a reduction in direct exchange access fee and analyze their impact on trading of Euro Stoxx 50 Index futures and the Xtrackers Euro Stoxx 50 Ucits ETF. A decrease in the frequency and duration of arbitrages following both events is observed, in addition to a reduction in arbitrage profits in the period after the reduction of the direct access fee. The results confirm the beneficial impact of speed of trading on the efficiency of financial markets, and support the theoretical predictions of Foucault et al. (2017) and Biais et al. (2015). In addition, alternative market efficiency measurements – midquote return autocorrelation and variance ratios - show statistically significant improvements following both events, providing robustness to the presented results.

Third, this thesis examines the relationship between limit order submissions and liquidity. A negative relationship is observed between the limit order arrival rate and depth at the best quotes (limit order queue length) and a positive relationship between submissions and bid-ask spreads. This is consistent with queuing theory that predicts an increase in the limit order arrival rate increases the queue length and therefore the time to execution of a limit order. Consequently, liquidity providers cover the increase in costs and risks associated with the increase in the time to execution of limit orders by increasing bid-ask spread.