Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/142513
Authors: 
Fagan, Stephen
Gencay, Ramazan
Year of Publication: 
2008
Series/Report no.: 
EERI Research Paper Series 01/2008
Abstract: 
Futures contracts on the New York Mercantile Exchange are the most liquid instruments for trading crude oil, which is the world’s most actively traded physical commodity. Under normal market conditions, traders can easily find counterparties for their trades, resulting in an efficient market with virtually no return predictability. Yet even this extremely liquid instrument suffers from liquidity shocks that induce periods of increased volatility and significant return predictability. This paper identifies an important and recurring cause of these shocks: the accumulation of extreme and opposing positions by the two main trader classes in the market, namely hedgers and speculators. As positions become extreme, approaching their historical limits, counterparties for trades become scarce and prices must adjust to induce trade. These liquidity-induced price adjustments are found to be driven by systematic speculative behaviour and are determined to be significant.
Subjects: 
Liquidity
Futures Markets
Return Predictability
Volatility
Trader Positions
Directional Realized Volatility
Hedgers
Speculators
Position Bounds
JEL: 
G0
G1
C1
Document Type: 
Working Paper

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