Simultaneity and liquidity in US electricity futures

Previous research on liquidity in securities markets has studied the relationships between liquidity, trading activity and volatility, using single equation methods, mostly with data from US Treasury securities, stocks and foreign exchange spot markets. Such analyses are inadequate, because these relationships are determined simultaneously, and this should be taken into account in empirical research. Moreover, liquidity relationships in futures markets have received little attention, and liquidity in electricity futures markets appears to have been neglected. This paper, which addresses these issues, develops a simultaneous model of cost of liquidity, trading activity and volatility for the California- Oregon Border electricity futures contract. The results show a positive relation between cost of liquidity and volume, which is consistent with a dominant asymmetric information cost and/or increased volatility accompanied by increased volume. The results include also a positive volume-volatility relation (although theoretically ambiguous in sign), and an expected positive cost of liquidity- volatility relation. A comparison is made between the systems and limited information estimates.