Trading volume, bid-ask spread, and price volatility in futures markets

In this study, we examined the relations between trading volume, bid-ask sp read, and price volatility on four financial and metal futures. Hausman's ( 1978) tests of specification confirmed that trading volume, bid-ask spread, and price volatility are jointly determined. We estimated the parameters a nd elasticities of trading volume, bid-ask spread, and price volatility in a three-equation structural model, using the generalized method of moments (GMM) procedure. Results indicate that there was a positive relationship be tween trading volume and price volatility but an inverse relationship betwe en trading volume and bid-ask spread after we controlled For other factors. Furthermore, results show that price volatility had a positive relationshi p with bid-ask spread and a negative relationship with lagged trading volum e. In addition, we found that the ordinary least-squares parameter estimate s of each equation model were often severely underestimated in comparison w ith those consistent estimates obtained from the GMM estimation. Results fr om this study have important policy implications. Our results indicate that a transaction tax, which is analogous to a greater bid-ask spread, will re duce trading volume, although the reduction is not as great as we previousl y estimated. (C) 2000 John Wiley & Sons, Inc.