Essays on price formation in futures markets

This dissertation is comprised of two essays. The first essay analyzes the link between the intraday S&P500 futures price formation and the dynamics and the informativeness of order flow. By modeling the distribution of the change in transaction price, the study finds that the market-wide order flow induces permanent changes in the futures price. The existence of the equilibrium distribution of transaction prices at any point of time is established. Most of the variation in the futures price is found to be caused by public news rather than trading noise. Further the study analyzes the order flow informativeness under different market states determined by trading volume and dealer profitability. I find that order flow is more informative when the level of trading volume is low and income earned by dealers is low.; The second essay analyzes the contribution of trades executed on the trading floor, and trades executed electronically to price discovery in the S&P500 Index. The analysis is performed using transaction level S&P500 Index futures data for the period from January 3, 2000 to June 30, 2001. I find that the contribution of the Emini market to price discovery is greater than that of the trading floor. The evidence suggests that the contribution of the Emini market to price discovery increased over time, while its volatility declined. I find that the contribution of the Emini trades to price discovery is positively related to the determinants of trading activity such as trading volume and order flow. These findings suggest that at times when liquidity is high, informed investors will have greater propensity to execute Emini trades. The finding that order flow is positively related to the contribution of the Emini market to price discovery is consistent with Kurov and Lasser (2004) who suggest that Emini trades could be more informative because trade participants learn from large orders submitted to the floor and simultaneously place orders in the Emini market.