The Impact of Electronic Trading on Liquidity

During 1999 and 2000, three major futures exchanges transferred trading in stock index futures from open outcry to electronic markets: the London International Financial Futures and Options Exchange (LIFFE); Sydney Futures Exchange (SFE); and Hong Kong Futures Exchange (HKFE). These changes in trading systems provide unique natural experiments to assess the relative liquidity of open outcry and electronic markets. After controlling for price volatility and trading volume, bid-ask spreads are found to be lower under the electronic trading regimes implemented by all three exchanges, with significantly lower bid-ask spreads recorded for the electronic trading systems of the SFE and HKFE. This provides some evidence that electronic trading can facilitate higher levels of liquidity relative to floor traded markets. Evidence is found, however, that bid-ask spreads become wider in response to higher price volatility under electronic trading, relative to floor trading. This indicates that the performance of electronic trading systems deteriorates during periods of higher price volatility