FX Futures Invariance

We develop and empirically examine a novel intraday invariance relation among trading activity variables across a set of currencies in the foreign exchange (FX) futures market exploiting tick level data. Our Trading Invariance (TI) hypothesis reflects an equilibrium involving trade-offs between the risk per trade versus market liquidity as captured by the bid-ask spread and market depth. We observe exogenous breaks in the trading costs for many of the currencies, as the exchange lowered the tick size for individual contracts at different points in time. Using these incidents as quasi-natural experiments, we confirm that the remaining components of the TI hypothesis adjust to maintain the equilibrium by shifts in the trading intensity and market depth. In contrast, alternative invariance relations fail dramatically when confronted with this type of exogenous shock. We further confirm that the values of key coefficients in the TI relation are similar across assets and in good correspondence with the theoretically predicted values. Our results point towards a fundamental equilibrium mechanism that should be accommodated within existing market microstructure paradigms. Moreover, they have direct implications for market design and surveillance.