ELECTRONIC MARKETS AND FLOOR MARKETS: COMPETITION FOR TRADING VOLUMES IN FUTURES AND OPTIONS EXCHANGES

Abstract

The internationalization of financial markets and the increasing demand for risk management products have fueled the growth of derivatives markets. While most exchanges have experienced increasing volumes over recent years, the pace of growth varies widely across exchanges, and the established marketplaces face increasing competitive pressures. In this paper, we investigate whether the trading mechanism offered to derivatives investors influences growth in market volumes. In particular, we distinguish between manual open outcry and electronic trading. In a floor market, traders gather in a pit and announce their orders. They complete trades using a combination of hand signals and eye contact. In an electronic market, orders are submitted to a central order book, and trades are created according to a matching algorithm. Using volume data from 1990-1994 for futures and options exchanges worldwide, we compute growth rates for the largest contracts and find that contracts traded in screen-based exchanges have experienced faster growth than those traded in manual markets. We discuss several interpretations of the data, but conclude that electronic exchanges are developing a competitive advantage.