ASX 30-Day Interbank Futures

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1 ASX 30-Day Interbank Futures Investigating the process of price discovery following RBA cash Lee A. Smales University of New South Wales (UNSW) School of Banking and Finance The article examines microstructure issues in the Australian Interbank futures market by analyzing the price adjustment process following scheduled Cash Target Rate announcements by the Reserve Bank of Australia. In characterizing the market response, three distinct stages of price formation and liquidity provision are identified. Market expectations around the RBA decision are derived explicitly from 30-Day Interbank futures. The first trade following the RBA decision occurs after 220 seconds on average, and after 234 seconds and 1.73 trades the market has adjusted to the theoretical settlement price. Deviations from theoretical prices post-announcement are common, particularly when a large amount of uncertainty exists around the RBA decision. The potentially costly issue of stale price quotes is also addressed. Acknowledgement: Data in this article is provided by SIRCA.

2 INTRODUCTION This article explores the process that ASX 30-Day Interbank Cash Rate Futures (Interbank Futures) follow in adjusting to scheduled Cash Target Rate announcements by the Reserve Bank of Australia (RBA). Various works (Crain and Lee, 1995; Ederington and Lee, 1993, 1995; Frino and Hill, 2001; Kim and Sheen, 2001; Zou and Zhang, 2005) have considered the effect of macroeconomic announcements on asset price volatility. The general finding is that news releases result in a rapid increase in return volatility; whilst the majority of the effects are relatively short-lived and subside within the first minute, there is varying degrees of volatility persistence for periods ranging from fifteen minutes to several hours even when a market is acting efficiently. This may be explained by an increase in trading activity as market participants re-balance their portfolios in light of the news, information traders enter the market, and liquidity traders benefit from the elevated interest. Cook and Hahn (1989) were among the first to study the reaction of fixed income markets to monetary policy action; demonstrating that changes in the Fed Funds target rate produced large movements in short-term rates, and smaller but significant movements in intermediateand long-term rates. A number of studies (Kuttner, 2001; Fatum and Scholnick, 2008) have found that fixed-income asset returns and volatilities respond only to the surprise component in monetary policy announcements. In the Australian context, Kim and Nguyen (2008) and Smales (2011) find similar results on an inter-day basis. Fleming and Remolona (1999) utilize methods similar to that employed in this article, in analyzing the price formation process in the U.S. Treasury Market, and detect a two-stage adjustment process around macro-economic announcements; they do not investigate monetary policy announcements, and the nature of that paper does not allow for an examination of potential deviations from the theoretical price futures price following the data release. The use of 30-Day Interbank futures allows this study to address several issues that previous studies have not. Firstly, since the Interbank overnight cash rate published by the RBA is not dependent on liquidity factors, as in the US, or reserve requirements, as in Europe, the fixing rarely deviates from target. As such, the front-contract Interbank futures provide an explicit reading of market expectations on RBA Monetary Policy. Secondly, as the outcome of the policy announcement is in effect binary the RBA decision to change the target rate not is simultaneously revealed to all market participants at the scheduled time it is possible to gain an insight into trades that occur away from the theoretical price. Lastly, despite their importance in reflecting market expectations, the front-contract Interbank future is often discounted in the literature, on the basis that volatility disappears once the RBA target rate announcement is made early in the month; this provides an opportunity to rectify this issue and examine the shortest part of the yield curve. 2

3 The article examines microstructure issues in the Australian Interbank futures market by analyzing the price adjustment process following RBA Target Rate announcements. In characterizing the market response, three distinct stages of price formation and liquidity provision are identified. The first stage, leading up to the RBA announcement, is characterized by low volume and above average spreads as market participants exhibit uncertainty over the rate decision. During this stage, the possibility of asymmetric information makes market participants unwilling to trade. Immediately prior to the announcement bid-ask spreads widen considerably as market-makers adjust their quotes in response to the inventory risks of sharp price changes. A brief second stage is marked by a sharp response to the publically available announcement, and induces rapid price change together with a substantial increase in trading volume, as market participants swiftly adjust their portfolios in the light of the RBA rate decision. The high level of trading volume persists for some time, driven by inventory positioning rather than disagreement on the implications of RBA policy since the decision effectively fixes the settlement price of the front contract Interbank future. The final stage sees volume subside to lower levels, whilst bid-ask spreads revert to normality more quickly than trading volume. The first trade following the RBA decision occurs after 220 seconds, and after 234 seconds and 1.73 trades the market has adjusted to the theoretical settlement price. Deviations from theoretical prices post-announcement are common, particularly when a large amount of uncertainty exists around the RBA decision. The potentially costly issue of stale price quotes remaining in the exchange over the data release is also examined with 48% of first trades post-announcement occurring on a stale quote. The paper is organized as follows: In Section I, I describe the RBA Cash Target Rate Announcement, the nature of the 30-Day Interbank future market, and the data used in the analysis. I also explain how market expectations surrounding RBA can be derived from Interbank futures. In section II, the three-stage adjustment process of the front-contract Interbank future to RBA is detailed, and the implications for price formation and liquidity provision are discussed. In section III, the possibility of market participants erroneously trading at prices that deviate from the theoretical price post-announcement and the relation with stale prices is discussed. Section IV concludes. 3

4 I. DATA AND METHODOLOGY: THE RBA CASH TARGET RATE ANNOUNCEMENT AND 30-DAY INTERBANK FUTURES MARKET RBA Cash Target Rate Announcements The cash target rate is the primary instrument for the setting of monetary policy by the Reserve Bank of Australia (RBA). The RBA maintains the target interest rate by maintaining the balance in the official money market at that target rate. The RBA has eleven scheduled Board meetings a year, on the first Tuesday of every month except in January. From January 1998, until November 2007, the RBA Board s decision to change or leave the cash rate unchanged was announced in a media release, which is posted on the website of the RBA 1 as well as on news wires such as Reuters and Bloomberg, at 9:30am Australian EST (GMT+10). Since December 2007, the media release has occurred at 2.30pm Australian EST. From January 2004 to December 2010, the RBA made 77. Of these, the RBA raised interest rates on 15 occasions, cut interest rates on 6 occasions, and kept rates on-hold on 56 occasions. Table 1 reports the breakdown of policy announcements into rate rises, rate cuts and unchanged subcomponents. Despite long periods of RBA inactivity during this timeframe, the period is still of sufficient length to contain a full monetary policy cycle. The RBA only changed interest rates on scheduled meeting dates during this period. <Insert Table 1> This article examines how prices adjust to RBA in the frontcontract 30-Day Interbank futures markets. In effect, the announcement is a binary event for market participants whereby uncertainty surrounding the cash rate is resolved for the remaining life-time of the front-contract. Market participants in the futures market quickly analyze the implications of the RBA target rate news and adjust their portfolios accordingly. Discussion of market microstructure for the Interbank futures market, along with a detailed description of the data used for this study follow. 30-Day Interbank Cash Rate Futures Data The ASX 30-Day Interbank Cash Rate Futures contract 2 is cash settled against the monthly average of the Interbank Overnight Cash Rate as published 3 by the Reserve Bank of Australia for that contract month. Interbank futures allow users to hedge against fluctuations in the overnight cash rate, and allow market participants to form explicit views on anticipated changes in the official cash rate through outright trading. Since their introduction in August Reuters: 0#YIB:, Bloomberg: IBA<CMDTY> 3 Reuters: RBA36, Bloomberg: RBACOR<INDEX> 4

5 2003, liquidity in Interbank futures has increased substantially so that they are now the third most actively traded overnight interest rate futures contract in the world. Average daily volume in 2010 was 18,157 contracts, equivalent to a notional value of A$ 55bn, with the majority of trading concentrated in the four nearest contracts. The Interbank futures market effectively trades around the clock, with a brief hiatus between the day and night sessions. Trading hours are 8:34AM to 4:30PM (AEST) for the day session, and 5:14PM to 7:00AM (AEST) for the night session. All trading takes place electronically. The contracts are based on a notional sum of AUD 3,000,000, and are quoted in yield percent per annum in multiples of per cent. Deutsche Bank AG acts as official market maker and provides two way quotes across all 18-months of the Interbank futures strip. Data on 30-Day Interbank futures is collected from Thomson Reuters Tick History (TRTH), provided by SIRCA, for the period 6th January 2004 to 31st December The analysis focuses only on the 15-minute period either side of the 77 RBA that occur during this period as this adequately captures the dynamics of the price-discovery process that this study is interested in. Tic by tic data is used to examine the number of trades to reach the equilibrium price, although this is aggregated to minute-by-minute data for average volume and spreads in order to form adequate statistics. Estimating market expectations Within Australia the RBA is able to maintain the Interbank overnight cash rate very close to target (over the period considered the fixing rate deviates from target only 18 times in 1,800 observations, and only twice is the deviation greater than 1 basis point). Therefore, using the 30- day Interbank futures rate immediately prior to the rate announcement, it is possible to derive explicit ex-ante expectations on monetary policy decisions, using the following calculation: E R post = D m R IB D pre R prior D post (1) Where Rpost is the RBA target rate post announcement, Rprior is the RBA target rate applicable immediately prior to the announcement, Dm is the total number of days in the month in which the announcement takes place, Dpre is the number of days in the month prior to the announcement, and Dpost is the number of days for which the target rate announced will be effective. Announcements on which the market is expecting a 0-10% or % probability of a rate move, calculated using Equation 1, are classified as periods of certainty, otherwise the classification is uncertainty. Expectations surrounding 26 announcements are classified as high uncertainty against 51 of low uncertainty. Periods of high uncertainty are characterized by a lower average RBA target rate, with more aggressive target rate changes that tend to 5

6 reduce interest rates. Conversely periods of low uncertainty tend to occur when interest rates are higher, changes in the target are smaller and result in higher interest rates. <Insert Table 2> Re-arranging equation 1, and subtracting the rate from 100, will produce the theoretical price post-announcement; this assumes the RBA will only change the cash target rate following scheduled meetings something it has consistently done throughout the sample period, and in the period since The theoretical equilibrium price that Interbank futures should trade at following the release of the RBA Monetary Policy Decision is: Theoretical Price post = 100 D pre R prior + D p R post (2) II. THE ADJUSTMENT PROCESS The impact of RBA cash is characterized through a minute-byminute examination of Interbank futures market behavior. Announcement days are disaggregated by levels of market uncertainty surrounding the RBA announcement. Panels A and B of Table 3 presents means of trading volume, along with the differences between the disaggregated groups, for the one-minute intervals during the period 5-minutes prior to the announcement to 10-minutes post announcement. Trading volume is measured as the number of contracts, and the number of transactions. Panel C of Table 3 presents the mean bid-ask spread measured as the mean proportional spread, together with the differences between the two groups. Figure 1 depicts the same data over a period of 15-minutes prior to the announcement, and a period of 15-minutes post announcement. <Insert Table 3> The period leading up to the RBA target rate announcement is characterized by low volume and above-average spreads. As the scheduled release time approaches trading volume falls further and spreads start to widen. Examining the disaggregated data shows no difference in mean trade volumes prior to the announcement, but the number of trades is significantly higher in periods of uncertainty; this results in a lower average trade size prior to announcements with a high degree of uncertainty. Panel C of Table 3 shows that bid-ask spreads are at their widest immediately prior to the announcement as quotes are cancelled, and market-makers adjust their quotes in response to the inventory risks of sharp price changes. At their widest, the average bid-ask spread is which is 16 times the average in normal market conditions. The disaggregated data shows that spreads start to widen earlier (in the (-5,-4) interval rather than (-3,-2) interval) and to a greater extent (for example (-1,0) period spreads of versus 0.062) when there is a larger amount of uncertainty around the announcement. 6

7 The smaller average trade size during this period is suggestive of informed traders attempting to disguise their trades in order not to move the market against them prior to the announcement, although this is unlikely given the information restrictions imposed by the RBA. An alternative explanation could be due to the lower liquidity in the market in terms of both market depth and wider bid-ask spreads; this reflects dealer reluctance to make markets at a time of potentially volatile price changes. This behavior is consistent with the inventorycontrol models of Ho and Stoll (1983), and O Hara and Oldfield (1986), which emphasize the increased risk to market-makers of high price volatility. In the Interbank futures market, the effort to control inventory risk prior to RBA target rate decisions causes some dealers to widen their quotes and others to withdraw quotes entirely 4, this includes the official marketmaker. The second stage of the adjustment process occurs as the RBA decision is released to the market. There is a sharp response to the announcement inducing a rapid price change together and, contrary to the U.S. Treasury Market findings by Fleming and Remolona (1999), there is a substantial increase in trading volume as market participants adjust their inventory in light of the rate decision. As Panel A and B depict, trading volume is at its highest in the minute following the announcement, in terms of contracts traded and the number of transactions. An average of 1,708 lots is traded at this time, a multiple of 32 times the average in the period immediately preceding the announcement. Uncertainty around the prospective RBA decision results in trading volume that is lower than that in more certain times for the immediate aftermath of the announcement only; all other periods see greater volume together with a greater number of transactions in the high uncertainty case. Trading volume also subsides more slowly in the case of high uncertainty. Panel C shows that bid-ask spreads remain wide in the period immediately following the announcement; spreads fall to the minimum within a minute in time of more certain expectations, but remain elevated for up to 10-minutes in less certain instances. Trading volume is elevated following the announcement as market expectations are realized, information uncertainty is resolved and market participants seek to quickly re-balance their portfolios. Trading volumes remain elevated as some traders take longer to digest the new information, and others seek tighter bid-ask spreads in order to execute a sufficient volume of business. One question is why bid-ask spreads remain large when the new theoretical price can be calculated instantaneously following the release of the announcement. One possibility is that traders are exploiting links between Interbank futures and other markets. For instance, participants in the FX forwards or AUD OIS market may derive their prices from the strip of Interbank futures and so a wider spread in one Interbank contract could result in a mispricing in one of the other markets if the pricing tool is not re-calibrated correctly following the announcement. <Insert Figure 1> 4 On 5 occasions the order-book is completely empty at the time of the announcement. 7

8 The final stage of the adjustment sees bid-ask spreads revert to normal levels, below that exhibited in the market prior to the announcement. In general, volume is reduced to lower levels, although there is a small spike higher in the (13,14) and (14,15) minute intervals 5. The resolution of information uncertainty allows market-makers to tighten bid-ask spreads and since the RBA announcement is effectively a binary event for the front-contract Interbank future there is little reason to continue trading the contract once inventory levels have adjusted to the announcement. For market participants, with constrained capital, seeking profitable trading opportunities there seems little reason in holding front-contract futures post-announcement and it is this unwinding of positions that likely result in the high volume. An example of the adjustment process The Interbank futures market response to the 3 rd November 2009 RBA cash target rate announcement provides an example of the adjustment process already described. In the period prior to the scheduled announcement there is little trading activity and as the announcement approaches the Bid-Ask spread starts to widen. As the RBA decision to raise the target rate by 0.25% is broadcast to the market, the price jumps to the new equilibrium and volume increases substantially whilst spreads remain elevated. Volume and spreads decline following a brief period of high activity as market participants adjust their inventory. <Insert Figure 2> Investigating the determinants of trade volume and bid-ask spreads The determinants of trade volume and bid-ask spreads around RBA cash target rate decisions are examined further using a simple OLS model. The regression equations utilized are as follows: Volume t = β 0 + β 1 Time t + β 2 Expect t + β 3 News t + β 4 Uncertainty t + β 5 OI t + ε t BA Spread t = β 0 + β 1 Time t + β 2 Expect t + β 3 News t + β 4 Uncertainty t + β 5 OI t + ε t (3A) (3B) Where Timet divides the sample period into thirty one-minute intervals around the RBA announcement. Expectt utilizes equation 1 to calculate market expectations on the RBA decision immediately prior to the release. Newst is the news effect parameter; the difference between the actual RBA decision and market expectations, this parameter takes a value of zero prior to the announcement since there is no news in that period. Uncertaintyt is a dummy variable accounting for the level of market uncertainty surrounding the RBA decision, and OIt is the level of Open Interest in the front-contract future on the settlement day immediately prior to the RBA announcement. <Insert Table 4> 5 Examining a longer time interval demonstrates that volume falls away again following this spike. 8

9 Table 4 displays the regression output. There is a negative relationship between Timet and both spreads and volume, indicating that further from the scheduled announcement time, the lower are bid-ask spreads and trading volume; this is no surprise given the prior analysis. The size of market expectations has a positive impact on bid-ask spreads, indicating that as market expectations increase, then so does the spread. Potentially this is indicative of a greater perception of inventory and market risk as market expectations increase. Uncertainty does not seem to have a significant effect in general; perhaps as this is related to the market expectations variable, however, it has a highly significant effect on post-announcement volume with a higher degree of uncertainty greatly increasing the volume traded. The news effect has a significant impact on post announcement spreads, with greater deviations from expectations resulting in wider spreads and much lower trading volume. As market makers are caught unawares by the RBA decision, spreads widen and volumes decrease markedly, perhaps as participants take time to digest the information release and calibrate their pricing models. Finally, open interest has a negative impact on spreads and a positive impact on volume suggesting that a higher level of open interest is indicative of a greater degree of market liquidity. III. DEVIATIONS FROM THEORETICAL PRICE POST-ANNOUNCEMENT Following the release of RBA cash rate target policy announcements it is straight-forward to calculate the theoretical settlement price of the front-contract Interbank future using equation 2, assuming that there will be no unscheduled RBA policy movements 6. However, tic-by-tic data demonstrates that the market does not always jump straight to the correct theoretical price. Table 5 exhibits summary statistics for trading activity in the front-contract Interbank futures following the scheduled release of RBA monetary policy decisions. In aggregate, the first trade post-announcement occurs after 220 seconds, it takes 234 seconds and 1.73 trades for the market to adjust to the new equilibrium which is the theoretical settlement price. A larger amount of certainty in the market as to the RBA decision prolongs the time taken to trade, and the number of trades taken to reach the theoretical price falls to A large amount of uncertainty increases the time taken to average time to trade to just 99 seconds, this may be reduced even further if market liquidity was sufficiently high following the announcement; the number of trades taken to reach the theoretical price increases to 2.88 whilst the time taken falls to 136 seconds. The inventory control issue could explain this phenomenon; in the case of market certainty participants will already have adjusted their inventory prior to the announcement and will not require a quick adjustment of their portfolio, whereas under high uncertainty there may be a greater need for portfolio adjustments. The greater number of trades to reach the theoretical price under high uncertainty is a result of traders dealing at stale prices posted prior to the announcement, trades erroneously quoted at prices away from the theoretical price and also dealers 6 No RBA monetary policy changes have occurred intermeeting during the period since

10 potentially entering incorrect quotes in small volumes in the Interbank futures market to take advantage of mispricing opportunities in the larger OTC markets. The issue of stale quotes that are executed following the announcement is a potential issue for market participants; where stale quotes are defined as those quotes entered prior to the scheduled announcement. In aggregate, the first trade is against a stale quote on 48% of occasions in the sample, following announcements with high uncertainty this occurs 72% of the time. If the stale quote happened to be at the new theoretical price post-announcement then this may not be such a concern, and on the occasions that a trade has occurred on a stale quote following announcements with low uncertainty only 14% of the time have occurred away from the theoretical price. However, when the stale quote has traded following a high uncertainty announcement 61% of the occasions have witnessed a deviation from the theoretical price; potentially this is a very costly issue for participants yet such trading is easily avoided by amending or removing orders in the period around scheduled announcements. <Insert Table 5> Trading activity following the RBA monetary policy announcement of 7 th October 2008 illustrates the point. Following the collapse of Lehman Brothers in September 2008, the financial markets were in a period of high uncertainty. The front-contract Interbank future was pricing in a decrease in the cash target rate of 0.50%, equal in magnitude to the largest policy move since The RBA surprised the market with a reduction in rates of 1.00%. Following the announcement, the theoretical price is calculated at but trades occurred in the market at 94.00, 93.99, 93.90, 93.88, 93.86, 93.84, and The first trade occurred on a stale quote after 12 seconds, but it took 13 minutes for the market to absorb the information fully and adjust to the theoretical price. Whilst the transaction size in the Interbank futures during this period was small, there was potential for much larger transactions to occur in the OTC market on prices calibrated to the erroneous Interbank futures price. IV. CONCLUSION This paper presents an empirical investigation of the ASX 30-Day Interbank Futures market. Specifically the price discovery process following the scheduled release of RBA cash is examined, over the 30-minute period either side of the release. A three stage process is identified. The first stage occurs in the lead-up to the announcement and is characterized by low volume and above average bid-ask spreads that widen substantially immediately prior to the release. This is consistent with prior literature that market participants are seeking to avoid the problem of adverse selection, and more likely that they wish to avoid the inventory control problem over potentially volatile periods. The second stage occurs in the immediate aftermath of the announcement and is distinguished by rapid price 10

11 changes, and substantial increases in trading volume, whilst spreads remain wide. The trading volume increase is contrary to existing literature, but is consistent with market participants who are aiming to adjust the construction of their portfolio in light of the new information. The final stage sees volumes subside and spreads revert to normal as information uncertainty is resolved. The three stages are more pronounced when the data is disaggregated into periods of high uncertainty and low uncertainty around the RBA decision. The paper briefly examines the determinants of the bid-ask spread, and trading volume, over the 30-minute interval around the RBA announcement. OLS regression confirms that both volume and spreads decrease as time from the announcement increases. Market uncertainty has a highly significant effect on volume post announcement. Whilst the news effect, calculated as the deviation of the RBA decision from market expectations, has a positive relationship with bid-ask spreads, but a negative relationship with trading volume. Explicit market expectations surrounding the RBA decision can be derived from 30-Day Interbank futures. Finally, the paper finds that deviations from theoretical prices post-announcement are common, particularly when a large amount of uncertainty exists around the RBA decision, highlighting a potential area of trading profit for market participants, both in the Interbank futures market and related OTC markets. The potentially costly issue of stale price quotes remaining in the exchange over the data release is also emphasized. This may be one area in which the futures exchange seeks to include circuit breakers to protect market participants. 11

12 REFERENCES Amihud, Y., and H. Mendelson, 1980, Dealership market: Market making with inventory, Journal of Financial Economics, 8, Cook, T., and T. Hahn, 1987, The reaction of interest rates to unanticipated Federal Reserve actions and statements: Implications for the money announcement controversy, Economic Inquiry, 25, Crain, S., and J. Lee, 1995, Intraday volatility in interest rate and foreign exchange spot and futures markets, The Journal of Futures Markets, 15, Ederington, L., and J. Lee, 1993, How markets process information: News releases and volatility, The Journal of Finance, 48, Ederington, L., and J. Lee, 1995, The short-run dynamics of the price adjustment to new information, Journal of Financial and Quantitative Analysis, 30, Fatum, R., and B. Scholnick, 2008, Monetary policy news and exchange rate responses: Do only surprises matter?, Journal of Banking and Finance, 32, Fleming, M., and E. Remolona, 1999, Price formation and liquidity in the U.S. Treasury Market: The response to public information, The Journal of Finance, 54, Frino, A., and A. Hill, 2001, Intraday futures market behaviour around major scheduled macroeconomic announcements: Australian evidence, Journal of Banking & Finance, 25, Frino, A., and J.R. Cummings, 2006, Sydney Futures Exchange 30 Day Interbank Cash Rate Futures: An emerging opportunity for global institutions, SFE Market Insights, 9 th Edition Ho, T., and H. Stoll, 1983, The dynamics of dealer markets under competition, Journal of Finance, 38, Kim, S-J., and J. Sheen, 2001, Minute-by-minute dynamics of the Australian bond futures market in response to new macroeconomic information, Journal of Multinational Financial Management, 11, Kim, S-J., and D. Nguyen, 2008, The reaction of the Australian financial markets to the interest rate news from the Reserve Bank of Australia and the US Fed, Research in International Business and Finance, 22, Kuttner, K. 2001, Monetary policy surprises and interest rates: Evidence from the Fed funds futures market, Journal of Monetary Economics, 47,

13 Lee, C., B. Mucklow, and M. Ready, 1993, Spreads, depths, and the impact of earnings information: An intraday analysis, The Review of Financial Studies, 6, Lee, J., 2006, The impact of Federal Funds target changes on interest rate volatility, International Review of Economics and Finance, 15, Lyons, R., 1995, Tests of microstructural hypotheses in the Foreign Exchange market, Journal of Financial Economics, 39, O Hara, M., and G.S. Oldfield, 1986, The microeconomics of market making, Journal of Financial and Quantitative Analysis, 21, Smales, L., 2011, RBA Monetary Policy Communication: Examining the effect of target rate news on Australian interest rate futures, Working paper, University of New South Wales Zou, L., and Y. Zhang, 2005, Trading for news: An examination of intraday trading behaviour of Australian Treasury-bond futures markets, Working paper, Massey University 13

14 Panel A: Aggregate Trading Volume Panel A: Trading Volume Mean Time from announcement Mean Time from announcement Certainty Uncertainty 7 6 Panel B: Aggregate No. Transactions 7 6 Panel B: Trading Volume No. Transactions 5 5 Mean Mean Certainty t Uncertainty Time from announcement Time from announcement Panel C: Aggregate Bid Ask Spread Panel C: Bid Ask Spread Mean Time from announcement Mean Time from announcement Certainty Uncertainty Figure 1. Market Activity: Announcement day aggregate and disaggregated by market certainty around announcement. Intraday patterns for the front-contract 30-day Interbank Future are plotted by one-minute intervals for days on which the RBA Cash Target Rate announcement is made. The data is disaggregated by levels of market uncertainty surrounding the announcement: Announcements on which the market is expecting a 0-10% or % probability of a rate move are classified as periods of certainty, the classification is uncertainty otherwise. Panel A reports means of trading volume in terms of total number of contracts, Panel B reports means of trading volume in terms of the number of transactions, and Panel C reports the mean of the exchange quoted bid-ask spreads. The period of analysis is 6 January 2004 to 31 December 2010, and the times shown are deviations from the scheduled announcement time.

15 Panel A: Price Traded Panel B: Volume Traded Panel C: Bid-Ask Spread Figure 2. Market response to 3rd November 2009 RBA Cash target rate announcement. Patterns of prices traded, volume traded and bid-ask spread for front-contract Interbank future in the 30-minute interval around the November 2009 RBA target rate announcement. Panel A depicts the open, close, low and high prices for each one minute interval. Panel B shows the volume traded in terms of number of contracts in each interval. Panel C depicts the Bid-Ask Spread. The period of analysis is 6 January 2004 to 31 December 2010, and the times shown are deviations from the scheduled announcement time.

16 Table 1 Descriptive Statistics on RBA and surprises This table reports descriptive statistics for RBA. The period of analysis is 6th January 2004 to 31st December RBA Target Rate Announcements ( ) Total Rate Rise Rate Cut No Change Number of Announcements Proportion 100% 19% 8% 73%

17 Table 2 Summary Statistics: Market Expectations Surrounding RBA Cash Rate Target Announcements Summary statistics are provided for market expectations around RBA cash rate target announcements. Expectations are calculated using the current month 30-Day Interbank future for the month of the rate decision. The mean actual rate over the period is provided. The actual change in the RBA target rate, together with the absolute mean is reported. The data is disaggregated into meetings in which there is a low degree of uncertainty and a high degree of uncertainty. The period of analysis is 6th January 2004 to 31st December Obs. Actual Rate (Average) Actual Change (Average) Actual Change Rate Change Expectations (Absolute Mean) (Average) Absolute Rate Change Expectations (Average) Aggregate % Certainty % Uncertainty %

18 Table 3 Dynamics of Trading Volume, Transaction Numbers, and the Bid Ask Spread by One Minute Intervals One minute trading volume means, transaction number means, and bid-ask spread means are reported and compared in aggregate, and disaggregated into periods of low uncertainty, and high uncertainty for the front-contract 30-Day Interbank future. Trading volume is reported in terms of the number of contracts (each with a notional value of A$3 million), number of transactions in terms of actual transactions, and reported bid-ask spread is the actual mean proportional spread. The time interval stated is relative to scheduled release of the RBA cash target rate announcement. The period of analysis is 6th January 2004 to 31st December (-5,-4) (-4,-3) (-3,-2) (-2,-1) (-1,0) (0,1) (1,2) (2,3) (3,4) (4,5) (5,6) (6,7) (7,8) (8,9) (9,10) Panel A: Trading Volume Aggregate Certainty Uncertainty Difference in means t -statistic p -value *** *** *** *** *** *** ** Panel B: Trading Volume - No. Of Transactions Aggregate Certainty Uncertainty Difference in means t -statistic p -value ** *** *** *** *** *** *** ** *** * * Panel C: Bid-Ask Spread Aggregate Certainty Uncertainty Difference in means t -statistic p -value ** *** *** *** *** *** *** *** *** * *, ** and *** indicate significance at the 0.10, 0.05 and 0.01 levels respectively.

19 Table 4 Explanatory Factors for Bid Ask Spread and Volume OLS regression is performed in order to explain the bid-ask spread and volume of trading in the period around RBA cash. Time from announcement divides the sample period into fifteen one-minute intervals prior to the announcement, and fifteen one-minute intervals post announcement. Market expectations utilizes equation 1 to define the market expectation on the RBA decision immediately prior to the release. News effect is the difference between the actual RBA decision and market expectations, this takes a value of zero prior to the announcement. Uncertainty is a dummy variable accounting for the level of market uncertainty surrounding the RBA decision. Open Interest is the level of open interest in the front-contract Interbank future on the settlement day immediately prior to the RBA announcement. The period of analysis is 6th February 2004 to 31st December Dependent Variable BAS Volume BAS Volume BAS Volume BAS Volume BAS Volume BAS Volume (Aggregate) (Aggregate) (Aggregate) (Aggregate) (Pre-Ann.) (Pre-Ann.) (Pre-Ann.) (Pre-Ann.) (Post-Ann.) (Post-Ann.) (Post-Ann.) (Post-Ann.) Time from announcement ** ** *** * * *** *** *** *** Market expectations *** *** *** *** *** News effect *** ** *** *** *** Uncertainty (High/Low) ** ** ** *** *** Open Interest ** *** *** *** *** Observations R-Square *, ** and *** indicate significance at the 0.10, 0.05 and 0.01 levels respectively.

20 Table 5 Summary Statistics: Investigating Deviations from Theoretical Price Post Announcement Summary statistics are provided for trading activity in the front-contract Interbank future following RBA cash rate target announcements. Time to trade is the length of time following the announcement until the first transaction occurs in the market. Theoretical price is calculated using Equation 2. The mean number of trades and time required to achieve the theoretical price are displayed. A stale price is classified as a price that was quoted in the market prior to the announcement. The final column shows the proportion of occassions when a trade at a stale price post-announcement has not been at the new correct theoretical price. Aggregated and disaggregated results are presented. The period covered is 6th February 2004 to 31st December Trades to reach Time to reach Occassions on which 1st Occassions when 1st trade is stale Time to trade theoretical price theoretical price trade is stale price and not at theoretical price (secs) (No. Trades) (secs) (Proportion) (Proportion) Aggregate % 29.79% Certainty % 13.79% Uncertainty % 61.11% October % %

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