Futures Market Liquidity during the Financial Crisis

This paper examines how liquidity in two actively traded futures markets has been affected by the onset of the financial crisis that began on August 9, 2007. We measure changes to trading volumes, spreads, and the level and shape of order books and document that these traditional measures imply a dramatic withdrawal of liquidity from Eurodollar futures markets, which previously could have been argued to be one of the most liquid financial markets in the world. By contrast, liquidity in another liquid market, S&P 500 index futures, was far less affected. Trading volume of S&P futures actually rose substantially, and spreads and order book liquidity changed by only a fraction of what was witnessed in Eurodollars. A deeper investigation into high-frequency trading strategies finds that prior to the crisis, liquidity additions and withdrawals rapidly restored symmetry to the electronic limit order book in both Eurodollar and S&P 500 futures markets. Following August 9, 2007, these strategies changed in the two markets in opposite ways, with patterns consistent with aggressive liquidity traders more likely to wait on the sidelines in Eurodollar markets, yet maintain or enhance their activity in equity futures. We offer an explanation of these findings, suggesting that the crisis affected the liquidity of these two liquid markets in different ways because of (1) different adverse selection risks, (2) different availability of market substitutes, and (3) different clienteles that serve as the typical marginal provider of liquidity.