The effectiveness of position limits: Evidence from the foreign exchange futures markets

Ya Kai Chang; Yu Lun Chen; Robin K. Chou; Yin Feng Gau

doi:10.1016/j.jbankfin.2013.02.033

The effectiveness of position limits: Evidence from the foreign exchange futures markets

Ya Kai Chang, Yu Lun Chen, Robin K. Chou, Yin Feng Gau

Department of Finance

Research output: Contribution to journal › Article › peer-review

19 Scopus citations

Abstract

This study considers the effects of the relative size of hedger and speculator open interests and the potential impact of implementing position limits on the price discovery process in both JPY-USD and EUR-USD futures markets. Hedging trading exerts a negative impact, regardless of its size, on price discovery in futures markets. Hedgers are less likely to be information motivated, so their trading uniformly delays the price discovery process. However, there is a positive and nonlinear impact of speculators' trade size on price discovery, the contribution of which depends on the relative size of the speculative open interest. Contrary to conventional wisdom among regulators, speculative trading does not harm the market in terms of market efficiency; as long as the percentage of speculators' open interest is below an endogenously determined threshold (approximately 20% for EUR-USD and 16.3% for JPY-USD), speculative trading even improves futures market efficiency.

Original language	English
Pages (from-to)	4501-4509
Number of pages	9
Journal	Journal of Banking and Finance
Volume	37
Issue number	11
DOIs	https://doi.org/10.1016/j.jbankfin.2013.02.033
State	Published - Nov 2013

Keywords

Hedging
Information shares
Position limits
Price discovery
Speculation

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10.1016/j.jbankfin.2013.02.033

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title = "The effectiveness of position limits: Evidence from the foreign exchange futures markets",

abstract = "This study considers the effects of the relative size of hedger and speculator open interests and the potential impact of implementing position limits on the price discovery process in both JPY-USD and EUR-USD futures markets. Hedging trading exerts a negative impact, regardless of its size, on price discovery in futures markets. Hedgers are less likely to be information motivated, so their trading uniformly delays the price discovery process. However, there is a positive and nonlinear impact of speculators' trade size on price discovery, the contribution of which depends on the relative size of the speculative open interest. Contrary to conventional wisdom among regulators, speculative trading does not harm the market in terms of market efficiency; as long as the percentage of speculators' open interest is below an endogenously determined threshold (approximately 20% for EUR-USD and 16.3% for JPY-USD), speculative trading even improves futures market efficiency.",

keywords = "Hedging, Information shares, Position limits, Price discovery, Speculation",

author = "Chang, {Ya Kai} and Chen, {Yu Lun} and Chou, {Robin K.} and Gau, {Yin Feng}",

note = "Funding Information: The authors thank Thomas Chiang, Jin-Lung Lin, Ike Mathur (the Editor), Dean Paxson, and an anonymous referee, as well as seminar participants at the 24th Australasian Banking and Finance Conference, the 2012 FMA Annual Meeting, the 2012 Southern Finance Association Annual Meeting, Chongqing University, National Dong Hwa University, National Taipei University, Shandong University, and University of Macau for their helpful comments and suggestions. Robin K. Chou gratefully acknowledges financial support from the National Natural Science Foundation of China (No. 71232004 ). Yu-Lun Chen gratefully acknowledges financial support from the National Science Council (NSC 101-2410-H-033-026). Yin-Feng Gau gratefully acknowledges financial support from the National Science Council (NSC 99-2410-H-008-009-MY2). ",

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AB - This study considers the effects of the relative size of hedger and speculator open interests and the potential impact of implementing position limits on the price discovery process in both JPY-USD and EUR-USD futures markets. Hedging trading exerts a negative impact, regardless of its size, on price discovery in futures markets. Hedgers are less likely to be information motivated, so their trading uniformly delays the price discovery process. However, there is a positive and nonlinear impact of speculators' trade size on price discovery, the contribution of which depends on the relative size of the speculative open interest. Contrary to conventional wisdom among regulators, speculative trading does not harm the market in terms of market efficiency; as long as the percentage of speculators' open interest is below an endogenously determined threshold (approximately 20% for EUR-USD and 16.3% for JPY-USD), speculative trading even improves futures market efficiency.

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The effectiveness of position limits: Evidence from the foreign exchange futures markets

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