Chun-An Li (Taiwan), Hung-Cheng Lai (Taiwan)* The impac of he rading sysems developmen on bid-ask spreads Absrac Following he closure, on 30 June 2005, of he open oucry sysem on he Singapore Exchange (SGX), rading in MSCI Taiwan fuures on he SGX has since aken place under he elecronic sysem only. Prior o he change, however, a hybrid form of rading exised, wih open oucry and elecronic rading occurring side-by-side wihin he SGX. This sudy ses ou o invesigae he developmen of he SGX rading sysem and is impac on bid-ask spreads a he differen sages of full open oucry rading, simulaneous open oucry and elecronic rading, and elecronic rading only. Our resuls show ha liquidiy, as measured by daily bid-ask spreads, is lower under he elecronic rading sysem han i was under open oucry rading. We find ha here was no appreciable difference in daily bid-ask spreads under he elecronic rading sysem, eiher prior o, or afer, he closure of he open oucry pi. Furhermore, when he wo sysems were running side-by-side, daily bid-ask spreads were lower under he elecronic rading sysem han under open oucry rading. Based upon measures of bid-ask spreads, we find ha, in erms of liquidiy, he elecronic rading sysem has an advanage over open oucry rading. Keywords: bid-ask spreads, fuures, rading sysem. JEL Classificaion: G13. Inroducion The primary aim of his paper is o underake an invesigaion ino daily bid-ask spreads during he developmen of disinc ypes of rading sysems wihin he fuures markes. The open oucry sysem of rading on he Singapore Exchange (SGX) was closed on June 30, 2005, wih all rading in MSCI Taiwan fuures subsequenly aking place under he elecronic sysem only. However, prior o his significan change, wo disinc periods of developmen were experienced by marke paricipans rading in MSCI Taiwan index fuures conracs wihin he SGX. The firs of hese periods (from January 9, 1997 unil June 25, 2000) involved rading during regular hours only under he open oucry sysem only 1. The second period (from June 26, 2000 o June 30, 2005) involved simulaneous rading under boh he open oucry and elecronic rading sysems ha were fungible, wih he SGX permiing marke paricipans o choose beween he floor rading and elecronic rading sysems for mos fuures conracs during regular rading hours 2. The open oucry and elecronic rading sysems compared in his sudy have given rise o considerable analysis of his paricular issue over he pas decade, wih mos of his analysis having used bid-ask spreads o deermine wheher he Chun-An L Hung-Cheng La 2008. * Corresponding auhor. 1 Ever since November 10, 1997, MSCI Taiwan index fuures have been radable afer he marke close on he elecronic rading sysem. 2 The SGX approved an addiional elecronic rading session for is MSCI Taiwan index fuures conracs, wih he new session beginning on June 26, 2000 and running side-by-side wih open oucry rading from 8:45 am o 12:45 pm (Singapore Time). elecronic rading sysem is acually more efficien. The relaed works repored wihin he lieraure can be divided ino wo major caegories, he firs of which compares bid-ask spreads on he differen exchanges where simulaneous rading of conracs occurs under boh he open oucry and elecronic rading sysems. Pirrong (1996) provided evidence o show ha under such condiions, he spreads of fuures conracs were no wider wihin he open oucry marke (London Inernaional Financial Fuures and Opions Exchange, LIFFE) han wihin he elecronic rading marke (Deusche Terminborse, DTB) 3. However, he findings of Frino e al. (1998) suggesed ha wihin he LIFFE, bid-ask spreads were in fac wider han hose found in he DTB. Shyy and Lee (1995) had, neverheless, earlier demonsraed he reverse; ha bid-ask spreads were narrower in he open oucry marke. The second caegory conrass bid-ask spreads where conracs are raded under boh open oucry and elecronic rading sysems on a single exchange. Coppejans and Domowiz (1999) evaluaed he bid-ask spreads of such a marke, he GLOBEX overnigh rading sysem, in boh absolue erms and relaive o a liquid benchmark, he floor marke of he Chicago Mercanile Exchange (CME) 4. They found ha he bid-ask spreads in he S&P 500 fuures markes were almos he same under boh rading mechanisms. Aiken e al. (2004) also examined he ransfer of rading from an open oucry rading sysem o an 3 The esimaion resuls of Kofman and Moser (1997) also indicaed ha he effecive bid-ask spreads were virually idenical for boh exchanges. 4 Coppejans and Domowiz (1999) sudied elecronic rading in Deuschemark (DM), Japanese Yen (JY), and Swiss Frank (SF) fuures markes in he S&P 500. 51
elecronic rading sysem in he sock index fuures markes of hree exchanges, and wen on o presen evidence o sugges ha here was a reducion in bidask spreads following he inroducion of elecronic rading 1. Their sudy provided suppor for he proposiion ha, as compared o open oucry markes, elecronic rading faciliaed high levels of liquidiy hrough a reducion in bid-ask spreads. Copeland e al. (2004) neverheless offered conra-dicory conclusions o he findings of Aiken e al. (2004). Thus, as a resul of such conflicing findings from a number of he prior empirical sudies, i remains unclear as o wheher one paricular ype of rading sysem dominaes he oher, and his is essenially because, in heir overall evaluaion of he mechanisms for elecronic rading vis-à-vis open oucry rading, he prior sudies in his area have invariably suffered from eiher, or boh, of he following defecs: (i) hey have failed o conrol for he differences in he conrac definiions; and/or (ii) here was no aemp made o conrol for he differences in he sampling period. Despie a considerable number of sudies having already been carried ou in his area, very lile aenion has been paid o rading sysems in he ransiion sage, where here is he simulaneous occurrence of boh open oucry rading and elecronic rading wihin he same exchange 2. In conras o he prior sudies, we aim o fully examine changes in he daily bid-ask spreads resuling from he changes in he rading mechanisms during he hree disinc periods of developmen. We examine he evoluion of he fuures rading sysems from open oucry rading o elecronic rading, wih a paricular focus on he period when elecronic rading was aking place alongside wih open oucry rading. The concurren rading of MSCI Taiwan index fuures on boh he elecronic and open oucry markes of he SGX provides us wih a unique plaform for examining daily bid-ask spreads during such a sage of side-by-side rading. The design of our sudy has disinc advanages over hose of many of he prior sudies, since we focus on MSCI Taiwan fuures raded on he SGX under alernaive rading mechanisms. Our comparison is based upon he same index and conrac sizes and here are no differences ha migh possibly have some impac on he cusomer base. For his reason, he main objecives of his paper are: (i) o examine he daily bid-ask spreads prior o, and afer, he changes in he rading sysem; and (ii) o compare empirically he relaive liquidiy levels of he idenical SGX fuures conracs raded side-by-side under boh rading sysems (elecronic rading and open oucry rading) during regular rading hours. 1. Daa and mehodology 1.1. Daa. In order o deermine he impac on bid-ask spreads semming from he developmen of he rading sysem, we divided he fuures daa ino hree disinc periods: (i) full open oucry rading; (ii) sideby-side rading (boh open oucry and elecronic); and (iii) full elecronic rading (Figure 1). The basic noion behind his classificaion was an aemp o deermine wheher here were any discernible changes in bid-ask spreads across hese hree disinc ime periods. Elecronic rading permied alongside open oucry rading 26 June 2000 Side-by-side rading pi closed 30 June 2005 Elecronic rading Fig. 1. Developmen of he MSCI Taiwan fuures rading sysems Table 1. Trading hours on he MSCI Taiwan index 1 The hree fuures exchanges were he London Inernaional Financial Fuures and Opions Exchange (LIFFE), he Sydney Fuures Exchange (SFE), and he Hong Kong Fuures Exchange (HKFE). 2 See, for example, Gwilym and Buckle (1996), Frino e al. (1998), Wang (1999) and Tse and Zaboina (2001). 52 Noes: a The 50 day period excludes hose conracs ha were rolled over o he nex nearby conrac hree rading days prior o expiraion. b Trades execued during his session are for T+1 selemen in Singapore ime.
We obained ransacion daa on MSCI Taiwan Index fuures from he SGX for he 50-day periods prior o, and afer, each of he daes when changes in he rading sysem occurred. Deails of he rading hours for MSCI Taiwan Index fuures during our sample period are provided in Table 1. Since nearby fuures conracs are generally he mos acively raded, we used he daa on hese nearby conracs. Furhermore, in order o avoid any abrup price change from he prior expiraion dae, he conracs were rolled over o he nex nearby conrac hree rading days before expiraion 1. 1.2. Mehodology. Several mehods are available for he calculaion of bid-ask spread 2, wih one paricular measure, which does no impose bid and ask daa, being he auo-covariance spread esimaor proposed by Roll (1984) and Schulz (2000). Their esimaes work well wih inraday daa and are similar o measured effecive spreads 3. Since no informaion on bid and ask spreads is provided by he SGX for he period when only elecronic rading occurred, we use a modificaion of he Roll (1984) Di Invesmen Managemen and Financial Innovaions, Volume 5, Issue 1, 2008 esimaor, as suggesed by Schulz (2000), o measure he daily bid-ask spreads: Adjused Roll Spread = Table 2. Descripion of he dummy variables 2 1 cov( Pj, Pj ) 7 (1) 1 8 n 1 where P j is he price of ransacion j on day ; cov is he serial covariance of he price change calculaed from inraday prices; and n represens he number of observaions on day. According o a number of prior sudies, bid-ask spreads are largely deermined by rading volume and price volailiy 4 ; hus, we specify our model o conrol for changes in boh rading volume and price volailiy across he differen periods of developmen of he rading sysem. Trading volume (VOLUME ) is he daily volume of rades for rading sysem i on day ; and price volailiy (VOLATILITY ) is he inraday price volailiy for rading sysem i on day. We esimae he following D = 0 D = 1 Trading mechanism 50-day Periods Trading mechanism 50-day Periods i = 1 only prior o June 26, 2000 (side-by-side sage) afer June 26, 2000 i = 2 (side-by-side sage) prior o July 1, 2005 Elecronic only afer July 1, 2005 i = 3 Elecronic (side-by-side sage) prior o July 1, 2005 Elecronic only afer July 1, 2005 i = 4 (side-by-side sage) prior o July 1, 2005 Elecronic (side-by-side sage) prior o July 1, 2005 equaion as a means of assessing he impac of bidask spreads under he differen rading sysems: Adjused Roll Spread (2) 0 1Di 2 VOLUME D VOLATILITY, 4 i 3 VOLATILITY where i = 1, 2, 3, 4 denoe he differen rading mechanism periods; and D i is a dummy variable. A descripion of he dummy variables is provided in Table 2. 1 SGX fuures are raded on a monhly cycle. The consequence of rolling over oo early is ha i would resul in he use of less liquid conracs. We herefore rolled over o he nex neares conrac 3 days prior o he expiraion of he curren conrac. 2 See, for example, Soll (1989), George e al. (1991), McInish and Wood (1992). 3 In conras o he sudies of Roll (1984) and Schulz (2000), which measured he accuracy of he effecive spread esimaes, our sudy focuses on wheher he bid-ask spread is affeced by he developmen of he rading sysems. Thus, here is no aemp in he presen sudy o idenify any oher mehods ha migh provide greaer accuracy in he measuremen of bid-ask spreads. 4 See, for example, Ho and Soll (1983), Glosen and Milgrom (1985), McInish and Wood (1992) and Prucyk (2005). We use he square roo of rading volume so as o ensure ha he resuls are no dominaed by ouliers (McInish and Wood, 1992). The ineracive erm beween D i and price volailiy is included as a means of capuring he incremenal effec of D i on he daily bid-ask spreads of price volailiy, afer conrolling for changes in boh rading volume and price volailiy 5. This analysis enables us o isolae he impac of he changes in he rading sysem afer conrolling for changes in he deerminans of daily bid-ask spreads ha are likely o be driven by marke condiions. 2. Empirical resuls The descripive saisics for he daily adjused Roll bid-ask spreads, price volailiy and rading volume over he daily inervals are presened in Panels A, B, and C of Table 3. These ables provide deails of he diverse ransacion mechanisms for he respecive 5 We also examined variance inflaion facors (VIF) as a measure of collineariy; all of he resuls were wihin he accepable range, wih he excepion of he ineracive erm beween Di and rading volume. Hence, his ineracive erm was removed. 53
sages of full open oucry rading, side-by-side rading and full elecronic rading. Preliminary analysis of he daa on he effecs afer he change in he rading sysem shows ha here was a reducion in boh daily adjused Roll bid-ask spreads and price volailiy, whils also revealing an increase in rading volume. Table 3. Descripive saisics Panel A: only Adj. Roll Bid-ask spreads Price volailiy Trading volume 50 days before 6/26/00 Mean 0.1475 2.4353 9163 Median 0.1383 2.2109 8726 Sd. 0.0522 1.2142 2529.931 Panel B: Side-by-side rading Adj. Roll Bid-ask spreads a Price volailiy a Trading volume a 54 elecronic elecronic elecronic 50 days afer 6/26/00 Mean 0.1347 N/A b 1.8411 1.6931 9546 574 Median 0.1296 N/A b 1.6057 1.5436 9079 350 Sd. 0.1191 N/A b 0.8993 0.9805 2621.457 759.343 50 days before 7/1/05 Mean 0.0731 0.0353 0.6989 0.6960 10799 9664 Median 0.0736 0.0302 0.5254 0.5493 9650 9536 Sd. 0.0075 0.0176 0.4210 0.4350 5650.764 6109.065 Panel C: Elecronic only Adj. Roll Bid-ask spreads Price volailiy Trading volume Elecronic Elecronic Elecronic 50 days afer 7/1/05 Mean 0.0301 0.6756 19866 Median 0.0302 0.5162 18772 Sd. 0.0030 0.3626 7201.561 Noes: a Adj. Roll bid-ask spreads, price volailiy, and rading volume are calculaed over daily inervals and means, medians, and sandard deviaions repored. b In he iniial period of elecronic rading (saring on June 26, 2000), rading volume was very low wih infrequen ransacions; he daa necessary for he calculaions are herefore unavailable. The resuls presened in Table 4 also provide new evidence on daily bid-ask spreads during he period of side-by-side rading in he single fuures marke. Table 4 provides some evidence o show ha afer he closure of open oucry rading, boh mean and median daily price volailiy were slighly lower; however, he saisics were no significan. Table 4. Differences in means -ess Trading sysem a Adj. Roll Bid-ask spreads b Price volailiy b Trading volume b O vs. O(S) 0.385 2.508** 0.619 O(S) vs. E 40.269** 0.012 7.368** E(S) vs. E 0.180 0.088 7.538** O(S) vs. E(S) 22.366** 0.306 0.546 Noes: a O refers o open oucry rading only; E refers o elecronic rading only; O(S) refers o open oucry rading a he side-by-side sage; and E(S) refers o elecronic rading a he side-by-side sage. b ** indicaes significance a he 1% level; * indicaes significance a he 5% level. There was a discernible decline in average daily price volailiy following he inroducion of elecronic rading, wih he -ess comparing he means of he wo sages (open oucry rading only and open oucry rading during he side-by-side sage) indicaing ha he change in price volailiy was saisically significan a he 0.01 level. Neverheless, following he subsequen launch of full elecronic rading, we did no find ha open oucry conracs were he perfec complemen o liquid and robus open oucry markes. There is, however, a possibiliy ha his resul was driven by sysemaic changes in price volailiy and rading volume, since Panel B and Panel C also reveal saisically significan differences in boh of hese variables. This suggess, herefore, ha he resuls may be driven by exraneous variables, as opposed o he rading mechanism effec on bid-ask spreads. Table 5. Deerminans of daily bid-ask spreads (ime series daa) April 6,2000 Ocober 4, 2000 April 4, 2005 Ocober 6, 2005 April 4, 2005 Ocober 6, 2005 only vs. open oucry (side-by-side rading) (side-by-side rading) vs. elecronic only Elecronic (side-by-side rading) vs. elecronic only i = 1 i = 2 i = 3 Coefficien -saisic Coefficien -saisic Coefficien -saisic Consan 0.1789 2.2233 0.0651 23.8132** 0.0341 8.2222** Di 0.0265 0.6210-0.0435-17.0319** -0.0022-0.5657 Sqr (VOLUME) 0.0070 0.5799 0.0015 0.7069 0.0001 0.1074 VOLATILITY -0.0051-0.5562 0.0002 2.3999* -0.0001-0.5894 Di*VOLATILITY -0.0076-0.4014-0.0006-0.1924 0.0042 0.9552
Table 5 (con). Deerminans of daily bid-ask spreads (ime series daa) April 6,2000 Ocober 4, 2000 April 4, 2005 Ocober 6, 2005 April 4, 2005 Ocober 6, 2005 only vs. open oucry (side-by-side rading) (side-by-side rading) vs. elecronic only Elecronic (side-by-side rading) vs. elecronic only Adj. R 2-0.034 0.932-0.028 F-saisic 0.194 338.749** 0.355 No.of Obs. 100 100 100 Noe: ** indicaes significance a he 1% level; * indicaes significance a he 5% level. In order o ensure he validiy of our es for he impac of he developmen of he rading sysems on bid-ask spreads, i is necessary o implemen conrols for changes in boh price volailiy and rading volume during each developmenal sage. Table 5 presens he resuls of he regression on daily adjused Roll bid-ask spreads agains he dummy variables, rading volume, price volailiy and ineracive variables. The realized spreads in he same rading sysems were no significanly differen, eiher prior o, or afer, he launch of side-by-side rading (see i = 1 and i = 3, where he -values are 0.621 and 0.565). On he oher hand, he F-saisics indicae ha he model was significan for conracs in open oucry rading (sideby-side) vis-à-vis elecronic rading only, whils he adjused R 2 saisic was 0.932, hereby indicaing ha hese models have reasonable explanaory power. Our resuls reveal ha afer conrolling for cerain variables, such as price volailiy and rading volume, wihin he regression framework (see i = 2), daily bidask spreads were igher for elecronic rading. By conras, as regards he period of open oucry rading only vis-à-vis he period of open oucry rading during he side-by-side sage, he resuls indicae ha afer conrolling for oher variables, he launch of he elecronic rading sysem (which began on June 26, 2000) had no saisically significan impac on daily bid-ask spreads in he open oucry marke. The coefficiens on he ineracive erm were inconsisen in sign and had no appreciable significance across he hree regression models. Table 5 also indicaes ha afer conrolling for he deerminans of daily bid-ask spreads, he coefficiens of price volailiy were posiive and significan for open oucry rading during he side-by-side sage visà-vis elecronic rading only. This finding is also consisen wih he prior examinaion of he sock markes underaken by McInish and Wood (1992). In conras o Table 4, he resuls repored in Table 5 for open oucry rading during he period of side-byside rading vis-à-vis he period of elecronic rading only, do no conflic wih hose repored for he side-by-side period of open oucry and elecronic rading. These resuls sugges ha he spreads for elecronic rading were lower han he corresponding spreads for open oucry rading, even afer conrolling for variaions in spread ha may be aribuable o oher relaed variables. There is also no evidence o sugges ha he inroducion of elecronic rading sysem had any obvious associaion wih he decline in daily bidask spreads during he period of full elecronic rading. Therefore, here exiss only weak evidence of a negaive relaionship beween elecronic rading during he side-by-side period and he full elecronic rading period. Ineresingly, using a muliple cross-secional regression model o invesigae he rading mechanisms during he side-by-side period of open oucry and elecronic rading, afer conrolling for price volailiy and rading volume, he coefficien in D i was negaive and saisically significan (Table 6). This indicaes ha when open oucry rading and elecronic rading exised in parallel wihin he same fuures index, here was an increase in daily bid-ask spreads for floor-based rading. Regardless of he sage of developmen, afer conrolling for price volailiy and rading volume, we find ha elecronic rading resuled in upgrading overall marke liquidiy by reducing daily bid-ask spreads. Table 6. Deerminans of daily bid-ask spreads (cross secional daa) April 4, 2005 June 30, 2005 (side-by-side) wih elecronic rading i = 4 Coefficien -saisic Consan 0.0666 14.3911** Di -0.0408-12.2375** Sqr(VOLUME) 0.0025 0.0924 VOLATILITY 0.0001 1.3483* Di *VOLATILITY -0.0006-0.1374 Adj. R 2 0.822 F-saisic 109.518** No. of Obs. 100 Noe: ** indicaes significance a he 1% level; * indicaes significance a he 5% level. 55
Conclusions This sudy has assessed he impac of he developmen of rading sysems on overall daily bid-ask spreads, wih he SGX offering an ideal environmen for such analysis, having passed hrough hree disinc sages of sysemic change; a full open oucry rading sysem, a simulaneous open oucry and elecronic rading sysem, and a full elecronic rading sysem. Our sudy has focused on he MSCI Taiwan fuures raded on he SGX under hese hree alernaive rading mechanisms. The fuures conracs examined here were based upon he same index and conrac sizes; furhermore, here were no differences ha migh affec heir cusomer base. We find from he References resuls ha daily bid-ask spreads were higher under he open oucry rading sysem boh prior o, and afer, he launch of elecronic rading. We also find ha here were no significan differences in daily bid-ask spreads under he elecronic rading sysem, eiher prior o, or afer, he closure of he open oucry pi. Finally, we also find ha daily bid-ask spreads under he elecronic rading sysem were lower han hose under he open oucry rading sysem during he period when he elecronic rading sysem was running alongside he radiional open oucry rading pi. These lower spreads seem o sugges ha an elecronic rading sysem has greaer liquidiy han ha of an open oucry rading sysem. 1. Aiken, M., A. Frino, A. Hill, E. Jarnecic. The impac of elecronic rading on bid-ask spreads: evidence from fuures markes in Hong Kong, London and Sydney // Journal of Fuures Markes, 2004. 24. pp. 675-696. 2. Copeland, L., S.A. Jones, K. Lam. The index fuures markes: is screen rading more efficien? // Journal of Fuures Markes, 2004. 24. pp. 337-357. 3. Coppejans, M., I. Domowiz. Price behavior in an off-hours compuerized marke // Journal of Empirical Finance, 1999. 6. pp. 583-607. 4. Frino, A., T.H. McInish, M. Toner. The liquidiy of auomaed exchanges: new evidence from German Bund Fuures // Journal of Inernaional Financial Markes, Insiuions, and Money, 1998. 8. pp. 225-241. 5. Glosen, L.R., P.R. Milgrom. Bid, ask and ransacion prices in a specialis marke wih heerogeneously informed raders // Journal of Financial Economics, 1985. 14. pp. 71-100. 6. Gwilym, O., M. Buckle. An analysis of bid-ask spreads on American and European syle index opions // Applied Economic Leers, 1996. 3. pp. 445-449. 7. Ho, T., H. Soll. The dynamics of dealer markes under compeiion // Journal of Finance, 1983. 38. pp. 1053-1074. 8. Kofman, P., J.T. Moser. Spreads, informaion flows and ransparency across rading sysems // Applied Financial Economics, 1997. 7. pp. 281-294. 9. McInish, T., R. Wood. An analysis of inraday paerns in bid-ask spreads for NYSE socks // Journal of Finance, 1992. 47. pp. 753-764. 10. Pirrong, C. Marke liquidiy and deph on compuerized and open oucry rading sysems: a comparison of DTB and LIFFE bund conracs // The Journal of Fuures Markes, 1996. 16. pp. 519-543. 11. Prucyk, B. Specialis Risk Aiudes and he Bid-Ask Spread // The Financial Review, 2005. 40. pp. 223-255. 12. Roll, R. A simple implici measure of he effecive bid-ask spread in an efficien marke // Journal of Finance, 1984. 39. pp. 1127-1139. 13. Schulz, P. Regulaory and legal pressures and he coss of Nasdaq rading // Review of Financial Sudies, 2000. 13. pp. 917-957. 14. Shyy, G., J.H. Lee. Price ransmission and informaion asymmery in bund fuures markes: LIFFE vs. DTB // Journal of Fuures Markes, 1995. 15. pp. 87-99. 15. Soll, H. Inferring he componens of he bid-ask spread // Journal of Finance, 1989. 44, pp. 115-134. 16. Tse, Y., T. Zaboina. Transacion coss and marke qualiy: versus elecronic rading // Journal of Fuures Markes, 2001. 21. pp. 713-735. 17. Wang, J. Asymmeric informaion and he bid-ask spread: An empirical comparison beween auomaed order execuion and open oucry aucion // Journal of Inernaional Financial Markes, Insiuions, and Money, 1999. 9. pp. 115-128. 56