Essays on extreme events in agricultural futures markets

In the past decade, agricultural commodity futures markets have experienced both the adoption of electronic trading platforms and heightened market fundamentals uncertainty. This has resulted in increased interest among market participants and regulators in understanding the impact and implications of extreme events in agricultural futures markets under the new trading environment. This dissertation sheds light on this issue from three different perspectives. First, we examine whether liquidity provision is robust to extreme market conditions characterized by “flash events” in agricultural futures markets. Second, we investigate whether the current price limit rule is effective in cooling off agricultural futures markets in the presence of large price shocks and how it affects the limit-free options market. Third, we focus on extracting information from options and futures markets to understand the role of extreme events in the pricing of variance risks. The first chapter examines the behavior of liquidity supply during “flash events” and whether it differs from that on normal trading days. “Flash events” characterize significant price changes observed within a short period of time. The emergence of such events has raised widespread concerns on whether futures liquidity is becoming more fragile as the share of automated trading continues to increase. Using intra-day data of the limit order book (LOB), we examine liquidity resilience during “flash events” in corn and lean hog futures markets from 2014 to 2019. Overall, we find little evidence that the liquidity provision becomes fragile when large price movements occur. Our analysis suggests that liquidity dynamics during these events is consistent with the notion that “flash events” are reflective of the increasing speed of price discovery in the modern era of automated trading instead of market instability. The second chapter studies whether price limits help resolve uncertainty and facilitate liquidity provision in the lean hog and live cattle futures markets and how they affect trading in the limit-free options market. In contrast to previous literature which is based on daily data, we use intraday futures and options data from 2014 to 2019 which allows for a better characterization of market behavior around limit moves. Consistent with microstructure theories, we find that price limits neither reduce volatility nor improve liquidity. Instead, they add to the high uncertainty that precedes the limit move, leading to significantly higher volatility and lower liquidity when trading resumes. Further, contrary to the notion that trading migrates to the limit-free options market, options volume drops and liquidity drains during limit moves. The options-implied futures price is only a biased, inefficient, and highly noisy estimate of the equilibrium futures price on locked-limit days. Overall, the findings suggest that rather than allowing the markets to cool off, price limits adversely affect market quality in presence of large price movements. The third chapter decomposes the variance risk premium into a diffusive and a jump component and gauges their relative importance in driving the willingness to hedge volatility risks. Variance risks can arise from uncertainty on future diffusive volatility and uncertainty on future jump volatility. In this paper, we use options and high-frequency futures data in the corn and soybean markets to extract the risk-neutral (options-implied) and physical (futures-based) expectation on future diffusive and jump volatility. The difference between the risk-neutral and physical expectation quantifies the price paid for protection from unexpected increases in the two components of future volatility. Our main findings show that the willingness to hedge increases in jump tail volatility is the major source of the negative variance risk premium observed in corn and soybean futures markets. Furthermore, we find that the willingness to hedge increases in jump tail volatility in the two markets is substantially higher in the summer and prior to USDA announcements, while the willingness to hedge increases in diffusive volatility is most sensitive to the level of overall uncertainty both in the underlying futures market and in the macroeconomy. Overall, our findings point to high uncertainty perceived by market participants on future jump volatility and strong risk aversion to unanticipated large jumps in agricultural futures markets.

Name thesis:degree_name

Ph.D.

Level thesis:degree_level

Dissertation

Discipline thesis:degree_discipline

Agricultural & Applied Econ

Grantor

University of Illinois at Urbana-Champaign

Year dc:date

2022

Author dc:creator

• He, Xinyue

Contributors dc:contributor

• Serra, Teresa
• Garcia, Philip
• Irwin, Scott
• Wang, Xiaoyang

• Futures markets
• Agricultural commodities
• Price analysis
• Liquidity
• Price limits
• Variance risk premium

Statement dc:rights

• Copyright 2022 Xinyue He

Language dc:language

en, eng

Handle dc:identifier

https://hdl.handle.net/2142/116035

OAI record oai:identifier

https://www.ideals.illinois.edu/oai-pmh?verb=GetRecord&metadataPrefix=etdms&identifier=oai%3Awww.ideals.illinois.edu%3A2142%2F116035