Volume and volatility surrounding quarterly redesignation of the lead S&P 500 futures contract

During the last weeks before each quarterly expiration of Standard & Poor's (S&P) 500 futures, the bulk of trading volume begins to shift away from th e next-to-expire (nearby or lead) contract toward the second-to-expire (nex t out) contract. At some point, the exchange formally redesignates the next out as the new lead contract, and the next out replaces the nearby in the futures pit location designated for the lead contract. This event invariabl y results in a dramatic increase (decrease) in trading activity in the next out (nearby) contract. This shift in relative trading volumes is due to th e microstructure of the futures exchange rather than new information or und erlying volatility conditions. The event thus offers us an opportunity to e xamine how volatility responds to noninformation-based exogenous changes in volume. This study examines the volatility behavior of nearby and next out S&P 500 futures contracts on the 10 days surrounding quarterly redesignati on of the lead contract. Our model measures possible changes in (a) the lev el of volatility and/or (b) the association between volume and volatility a fter redesignation of the lead contract. Results indicate that when we acco unt for the association between volume and volatility, the higher volume le ad contract consistently experiences a lower level of volatility. This outc ome supports the view that the larger population of liquidity providers who trade the more active lead contract fosters greater market depth and lower volatility. (C) 2001 John Wiley & Sons, Inc.