Do locals influence volatility in futures markets?

Abstract

Recent studies cast doubt on the long held belief that locals in futures markets are market makers and provide liquidity to other users of futures contracts. If locals are speculators or noise traders instead of market makers they may add to market volatility. Using 3-year bond futures and Share Price Index futures data from the Sydney Futures Exchange, this paper examines the impact of trading by locals on returns and volatility within a GARCH framework. After controlling for microstructure and announcement effects, we find that (1) locals buy before price increases and selI before price decreases in bond and index futures; (2) locals buy during price increases in index future and sell during price increases in bond futures; (3) locals have a marginally negative effect on pricing errors; and (4) local trading volume has a significantly larger positive effect on return volatility than that of broker volume.