## Thursday, April 22, 2010

### Futures market liquidity: index vs. currency vs. an individual stock

In continuation of yesterday's blog post on the big quantities visible on the order book of the NSE currency futures market, I got hold of order book information for one recent timepoint (10:32 AM on 9 April) for three April expiry futures: Nifty, INR/USD and Reliance. This is not as good as looking at information for today or yesterday, but it's quite instructive.

Theory teaches us that liquidity varies with volatility and asymmetric information. Using daily returns for all points seen in 2010, the three vols (all annualised) for these three underlyings work out to:
• INR/USD: 6.6%
• Nifty: 15.2%
• Reliance: 24.5%
So we expect Reliance will be the least liquid, given the asymmetric information which afflicts individual firms and given the high volatility of Reliance. Both Nifty and INR/USD will have better liquidity since they are macroeconomic underlyings (with low asymmetric information). Of these, INR/USD will fare the best because it has a low volatility.

The data that I got was for the top 20 prices in the order book. This shows the following picture of how impact cost when buying (in basis points) varies with transaction size (measured in million rupees):

The blue line is the impact cost of Reliance. The quantity available in the top 20 prices is low, and the impact cost therein goes up rapidly from around 1 basis point `at the touch' to around 9 basis points at the end. This is the combination of high asymmetric information and high volatility.