Price discovery in the pits: The role of market makers on the CBOT and the Sydney futures exchange

This paper uses the methods of error correction and common factor analysis to estimate the contribution of locals (market makers who may participate directly by trading for their own account) and non-local traders to price discovery on the floor of the Chicago Board of Trade (CBOT) and the Sydney Futures Exchange (SFE) during a period when open outcry trading was used on both exchanges. We examine these two execution channels for the CBOT's U.S. Treasury bond contract and the SFE's three-year bonds, ten-year bonds, ninety-day bankers' accepted bills, and stock index contracts. For each of the futures contracts, the trade price series of local and non-local traders are cointegrated. VAR analysis reveals lag structures eight to fifteen trades long in the dynamic adjustment of equilibrium prices in these markets, but time spans of only one to three seconds within synchronous trades. We find evidence of multilateral price discovery by the two execution channels for each of the five contracts. Locals account for 44 to 73% of the price discovery in the four SFE contracts and for 58% of the price discovery in the CBOT's T-bond contract.