Liquidity Costs

and Scalping Returns in the

Corn Futures Market
B. Wade Brorsen

H edgers and speculators in futures markets who use market orders may pay a price
for getting their order filled quickly. Holbrook Working (1977) argued that an ur-
gent seller may have to sell at a price just below that of the last transaction while an ur-
gent buyer may have to pay a price just above the price for the last transaction. The
difference in price paid (received) by the urgent buyer (seller) is often called a liquidity
cost.' Any limit order can provide liquidity, but liquidity is primarily provided by floor
traders who bid and offer for their own account. Floor traders can be either day traders
who are short term speculators or scalpers who continually quote bids and offers against
which market orders can be executed. The scalpers provide liquidity, but they do so only
because they expect to earn a return.
Both speculators and hedgers who submit market orders through floor brokers should
be concerned about the size of these liquidity costs. Futures exchanges need to know the
size of liquidity costs to evaluate new alternatives such as electronic trading. Researchers
also need to know the size of liquidity costs so they can account for them when simulat-
ing hedging strategies or speculative trading. These same groups also need to know what
factors make these liquidity costs vary.
The purpose of this paper is to report research estimating the size of liquidity costs and
scalping returns in the corn futures market and to determine what factors are related to
the size of these costs and returns. The paper also provides information about the distri-
bution of intraday prices.

PREVIOUS RESEARCH
Previous research has found that intraday prices are negatively autocorrelated [see Work-
ing (1977), Martell and Helms (1979), Helms and Martell (1985), Trevino and Martell
(1984), and Thompson and Waller (1986)l. This negative autocorrelation results from
scalpers attempts at earning a profit from filling market orders. Orders to buy at the mar-

Helpful comments from Tim Baker, Jon Brandt, Scott Irwin, and Bill Uhrig and computational assistance
from Robert J. Nielsen and Louis P. Lukac are gratefully acknowledged.
'The stop orders used by some traders are market orders rather than limit orders. These are orders to sell or
buy at the market whenever a certain price is touched.
?his cost is in addition to commission costs. Thus, total transaction costs equal commission costs plus li-
quidity costs.

B . W a d e Brorsen is a n Associate Professor in the Department of

Agricultural Economics at Purdue University.

The Journal of Futures Markets, Vol. 9, No. 3, 225-236 (1989)

0 1989 by John Wiley & Sons, Inc. CCC 0270-73 14/89/030225-12$04.00
ket are transacted at the scalper’s ask price while orders to sell at the market are trans-
acted at the scalper’s bid price. Transaction prices fluctuating between bid and ask levels
cause prices to be negatively autocorrelated. Trevino and Martell (1984) simulated trad-
ing with a filter rule (see Alexander (1961)) on intraday data and found scalping returns
were positive when autocorrelation was negative. Based on simple correlation, they also
argued that volume was more important in determining scalping profits than maturity or
open interest. Helms and Martell (1985) argued that the generating process for intraday
prices is not stationary over time, but they did not test hypotheses about the factors that
would cause the distribution of prices to change over time. Thompson and Waller (1986)
also simulated trading with a filter rule and found returns tended to be larger when con-
tracts were nearer maturity.
Silber (1984) and Working (1977) studied the actions of scalpers by examining actual
trading records of scalpers. Each found that scalpers made little money per contract
traded implying liquidity costs are small. Working (1977) found that floor traders often
did both scalping and day trading. Silber (1984), however, examined the record of a
trader who was more of a pure scalper and held positions for an average of 2 minutes.
Silber (1984) concluded that the trader’s earnings came from providing liquidity to mar-
ket orders. The differences in the actions of the traders studied by Silber (1984) and
Working (1977) shows the difficulty of finding a trader who is truly “representative.”
Previous research has provided some information about the size of liquidity costs and
scalping returns; but none of these studies have used a regression model to test whether
the size of these costs and returns are influenced by factors such as: seasonality, maturity,
or volume. This paper uses intraday prices and, following Thompson and Waller (1986),
measures liquidity costs by the size of intraday price changes. Using the size of intraday
price changes as a measure of liquidity costs may yield a better measure of liquidity costs
than returns to scalpers since scalpers on average are likely to lose to information
trader^.^ Potential scalping returns are examined by simulating a simple scalping rule.
This avoids the difficulty faced by Silber (1984) and Working (1977) of trying to general-
ize the behavior of one trader as being representative of the behavior of other traders.
However, the simulation approach ignores the human element in that a floor trader has
other types of information such as the number of orders coming into the pits and who is
doing the trading. Neither does the simulation approach adequately account for risk
aversion by scalpers which Working (1977) argued was important. But, the simulation
approach does provide information about potential returns to a risk neutral trader which
provides a useful complement to the results of Silber (1984) and Working (1977).

POTENTIAL DETERMINANTS OF SCALPING PROFITS

Scalpers interviewed by Working (1977) (pp. 216-220) placed great importance on
recognizing and trading with trends. A scalper who failed to recognize trends could ex-
pect to lose some of the payments received for providing liquidity. If scalpers on the
whole lost to traders who had better information about fundamentals then both simulated
and actual returns to scalpers would underestimate liquidity costs. To the extent scalpers
are successful in recognizing trends, simulated returns may underestimate actual returns.
Assuming price changes that are due to scalping and those due to new information are
the same size, then the size of price changes would be a measure of liquidity cost as

’Information traders are defined as any trader who trades on the basis of information about changes in sup-
ply and demand conditions. They include the day traders defined by Working (1977), but may also include
traders who hold contracts for longer periods of time and are not floor traders.

2261 BRORSEN
Thompson and Waller (1986) (p. 116) argue. Liquidity costs measured by the size of
price changes would be larger than scalping returns since scalpers would lose when suc-
cessive price changes occur in the same direction. (This assumes that all market orders
incur liquidity costs.) The two measures should converge when all price changes are due
to scalping (i.e., no change in equilibrium price) and thus all successive price changes
occur in opposite directions.
Based on previous research, the three factors expected to influence liquidity costs,
scalping profits, and the distribution of prices are: maturity, volume, and seasonality.
Trevino and Martell (1984) found that autocorrelation became more negative (implying
scalping profits would increase) as contracts matured and volume increased. Anderson
(1985) found that the variance of daily (interday) prices increased as the contract ma-
tured, but that seasonality was statistically significant for corn while maturity was not.
The maturity effect has the weakest theoretical justification of the three factors.
Anderson (1985) credits Samuelson (1965) with developing the hypothesis that variance
of interday prices would increase as a contract matured. Anderson (1985) also points out
that the hypothesis is only valid under a set of restrictive assumptions. Intuitively, the
argument is that information about this year’s crop, this month’s export sales, etc. would
have more impact on current prices than on next year’s expected prices. An alternative
reason for considering maturity is that the composition of traders may change as the con-
tract matures. For example, market orders may be more frequent toward maturity and
thus provide more opportunities for scalping.
Trevino and Martell (1984) argued that volume was a more important factor than matu-
rity. As volume increases, time between transactions decreases and thus scalpers have an
opportunity to get in and out of the market quickly with little chance of prices changing
due to new information. Working (1977) argued that scalping returns would be highest in
the most liquid contracts. The reason is that scalpers would lose less to information
traders and some benefits would go to scalpers while some would go to those who submit
market orders. Thus, liquidity costs as measured by the size of price changes could de-
crease as volume increased, but returns to a simple scalping rule would increase. The
services of scalpers are rarely used in low volume months because of the size of liquidity
costs [Working (1977)l. Trevino and Martell (1984) argue that traders may foil scalpers
in low volume months by submitting a large order in small pieces. Also Working (1977)
and Cunningham (1979) point out that any position entered by scalping in distant con-
tracts is usually offset by a spread with a contract nearer maturity. Thus, in this paper
where price movements of each contract are studied separately, the action of scalpers in
the distant months may be missed. For this reason, Cunningham (1979) argues that only
the last four months of trading in a given contract are appropriate to study scalping.
Seasonality is a proxy for the quantity of new information. During the summer
months, information about weather and crop development is expected to cause frequent
price adjustments. Thus, a naive scalping rule would be expected to be less profitable
during these months. The size of price changes may be larger during these months. The
bid-ask spread may widen due to scalpers’ increased risk of losses to information traders
and there may also be some large price movements due to scalpers unwillingness to trade
when new information becomes available.
The quantity of scalping services demanded in a given time period should primarily
be affected by the price of scalping services and by volume during the time period. The
composition of traders may also change with maturity and seasonality so these factors
are also included. Thus, the demand for scalping services (Q”) is:
Q” = f,(liquidity costs, volume, maturity, seasonality) . (1)

LIQUIDITY COSTS AND SCALPING RETURNS / 227

The primary shifter of the supply of scalping services (Q’) is expected to be risk. Work-
ing (1977) emphasized scalpers were very concerned about risk. The risk faced by
scalpers is determined by the likelihood of new information becoming available between
transactions and can therefore be measured by volume, maturity, and seasonality:
Qs = f,(returns to scalping, volume, maturity, seasonality) . (2)
Returns to scalping will differ from liquidity costs by the returns to information traders:
liquidity - returns to - returns to
costs scalpers information traders (3)

Glosten (1987) uses arguments very similar to eq. (3). Glosten (1987) refers to liquidity
costs as the bid-ask spread, returns to scalpers as the part of spread arising from monop-
oly power, clearing costs, inventory carrying costs, etc., and the returns to information
traders as the part due to asymmetric information. The per transaction returns to infor-
mation traders will also be affected by volume, maturity, and seasonality:
returns to
= f,(volume, maturity, seasonality) . (4)
information traders
The system is then completed by equating supply and demand for scalping services:
QD = Qs

The structural eqs. (l), (2), and (4) can not be estimated directly since Q” and Qs are
not observed and the simultaneous equations are not identified. However, the reduced
form equations can be estimated. Thus, the reduced form equations for liquidity costs
and returns to scalpers are4
liquidity costs = g,(volume, maturity, seasonality) , (6)
and
returns to scalpers = g,(volume, maturity, seasonality) . (7)
Equations ( 6 ) and (7) are used to specify the regression equations used in the empirical
section. The expected signs are ambiguous in general since the right hand side variables
have different expected effects on the supply and demand for scalping services. If shifts
in the supply or demand for scalping services are small relative to shifts in returns to
information traders, however, then the expected signs suggested by past empirical
research can be obtained. For example, an increase in volume or a seasonal decrease in
the quantity of information would result in lower returns to information traders and thus
decreased liquidity costs and increased returns to scalpers.

PROCEDURES
One of the key elements affecting intraday price movements is the minimum price incre-
ment (sometimes called a tick). Corn prices must move in units of one-quarter cent per
bushel or $12.50 for a 5,000 bushel contract. Working (1977) defined a scalper as a
trader who was always willing to buy at one tick below the last price or sell at one tick
above it. Since prices will sometimes move against a scalper, this implies scalping
40ther factors such as the size of the market order and the degree of competition among scalpers (i.e., num-
ber of scalpers) also likely affect liquidity costs and returns to scalpers. These variables are not observed and
thus are not included in the empirical model. This does not bias the results if the relevant excluded variables
are not correlated with the included variables.

2281 BRORSEN
profits should be less than the minimum price change, which is what both Silber (1984)
and Working (1977) found. This might not be true if the minimum price change were set
too low and no scalper was willing to trade for such a small potential gain. Working
(1977) explains that the exchanges try to set the minimum price changes at the competi-
tive levels determined by the action of scalpers. He argues that when they are too large,
traders will trade parts of a order at different prices. If they are too small, prices can
move in units of twice the minimum price change.
The Chicago Board of Trade records the sequence of prices over time. The number of
transactions at each price is not recorded. The volume at each price is only recorded in
30 minute intervals and is not used here, therefore, since there is no way to allocate vol-
ume any time the same price occurs twice during the 30 minute interval. The intraday
prices used in this study are the Time and Sales data from the Chicago Board of Trade
for the corn futures contract. The data base contains a record of each price change and a
record of the type of trade (e.g., open, close, etc.) occurring for each price change. Any
data that did not represent an actual trade such as bids or asks were deleted. Six different
contract months were selected for study: July 1983, September 1983, December 1983,
March 1984, May 1984, and July 1984. The data set contained 381,956 observations not
counting the opens and closes which were used for the trading simulation.
Five descriptive statistics are used: (1) largest absolute value of price change, (2) av-
erage absolute value of price change, (3) standard deviation of log price changes, (4) rela-
tive kurtosis of log price changes, and ( 5 ) first-order autocorrelation of log price changes.
Trading is simulated using two naive scalping rules. The descriptive statistics and return
to the scalping rules are calculated monthly for each of the contracts. The six contracts
were traded between 15 and 17 months each and yielded a total of 97 monthly observa-
tions. Monthly statistics are only reported here for the May 1984 contract since the pat-
tern was similar for all contract months.
The largest price change shows the largest potential liquidity cost. The average abso-
lute price change and standard deviation measure the average size of price changes and
thus are an estimate of liquidity costs. The relative kurtosis shows the prevalence of
extreme price changes. The autocorrelation shows the prevalence of price changes due
to scalping and those due to new information. If all changes in price are due to scalp-
ing then all changes in price will be in the opposite direction and the autocorrelation
will be - 1. The standard deviation and autocorrelation are calculated using log price
changes (A():
AP, = In Pi - In P,-l (8)
where Piis the j" new price observed. Log price changes can be interpreted as percent-
age price changes in continuous time. No interday price changes are included.
The two trading rules used are simple rules that a floor trader could actually use. They
are naive rules in the sense that they only consider information available in past prices
while a floor trader has access to other types of information. Both rules assume prices
will tend to reverse. Rule 1 is the simple scalping rule suggested by Working (1977),
buy if the current price is lower than the previous one and sell if the current price is
higher than the previous price. Rule 2 is, buy if the current price is lower than the previ-
ous two prices and sell if the current price is higher than the previous two prices.' These
rules are similar to the filter rule used by Trevino and Martell (1984), but the filter rule

5Nielsen and Brorsen (1986) considered making trading decisions based on the last 3, 4, 5, 10, 15, 25, 50,
and 100 prices using this same data set. They found that profit per trade decreased as the number of past prices
considered increased.

LIQUIDITY COSTS AND SCALPING RETURNS I 229

is based on the size of the price change while the rule used here is not. Also, Trevino
and Martell (1984) did not consider filter sizes smaller than 1/2 cent.
No overnight positions are allowed since this is the strategy usually followed by a
floor trader (Working (1977)). In actual use, a trader would probably modify these sys-
tems slightly to reduce risk, since large losses are possible if successive price changes
are in the same direction. The system always holds a position either long or short from
the initial trade after the open until the positions are offset at the close. Since the trading
system always offsets and reverses (except at the open and close) it implicitly assumes
two contracts can be traded at each price. Volume at each price is not known. Therefore,
the number of contracts traded in a particular month should only be interpreted relative
to values for other months.
A floor trader who is a member of the exchange pays a commission charge of $1.50
per contract traded. This commission is not subtracted for the trading simulation. Thus
$1.50 per raund turn must be subtracted to determine profits.
To test hypotheses about the factors influencing liquidity costs and scalping profits,
the following regression equation which is based on eqs. (6) and (7) was estimated by
ordinary least squares using monthly statistics:
=
T,~ a.+ a,cos(2r*MO/12) + a2sin(2r*MO/12) + a3cos(2r*M0/6)
+ a4sin(2r*M0/6) + A,t + A2Vo11,
j = 1, . . . , 6 t = 2, . . . , 5 (9)
where 7rIr is either the standard deviation of the log price changes which are defined in
eq. (8) (which measures the size of price changes and thus corresponds to liquidity
costs) or trading system returns per contract traded (which measures per unit returns to
scalpers) for contract j at t months from maturity, neither of the two measures are per-
fect measures of the dependent variables implied by eqs. ( 6 ) and (7), but they should
be highly correlated. The sine and cosine terms are included to capture seasonality, Vol,,
is the total volume of trading during the month for contract j , MO is the month (1 =
January,. . . , 12 = December), and ak,k = 0, . . . ,4,and A,, i = 1 , 2 are parameters.6
The regression equation is estimated using just the 4 months prior to the expiration
month since in the other months scalping usually occurs through spreads. Thus,
24 observations are used for the regressions. The equations are weighted by the number
of observations used to calculate the monthly statistics. Since the dependent variable is
aggregated, this weighting should produce more efficient estimates. The weighted and
unweighted regressions produced similar results, but only the weighted regressions are
presented.
RESULTS
Scalpers appear to be the dominant force in intraday price movements. The results show
frequent negative autocorrelation and positive scalping returns. Of the 97 different
months of trading, 64 had statistically significant negative first-order autocorrelations.
Only 17 of the 94 months had statistically significant positive first-order autocorrelations.
Trading returns for Rule 1 and Rule 2 were positive in 67 and 68 months, respectively.
The positive autocorrelations and trading system losses were either in the low volume
early months of the contract or the delivery month. Table I shows this pattern for the
May 1984 contract.
61n addition to the linear specification in (2), a model adding quadratic terms for maturity and volume was
also estimated because of possible nonlinear relationships between the variables. Conclusions were similar, so
only the linear model is reported here since it is easier to interpret.

2301 BRORSEN
 Table I
DESCRIPTIVE STATISTICS OF INTRADAY FUTURES PRICES FOR MAY 1984 CORN"
Max. Abs. Avg. Abs.
Price Price First- Rule lb Rule 2
Change Change Standard Order
(cents/ (cents/ Deviation' Relative Autocor- Returns No. Returns No.
Date bushel) bushel) (% x 100) Kurtosis' relation' ($/trade) Trades ($/trade) Trades

Jan. 83 1.oo .34 11.92 -1.13* .203* .58 108 - 10.98 33

Feb. 83 1.50 .36 13.25 .15 - .005 -2.88 200 -4.30 96
Mar. 83 2.00 .33 11.80 .91* .003 -1.86 350 -6.73 156
Apr. 83 .75 .28 9.16 - 1.35* .275* -9.54 275 -9.53 143
May 83 1.oo .28 9.37 - 1.06* .189* -6.39 352 -8.57 156
June 83 .75 .28 9.82 - 1.34* .173* -5.83 40 1 -5.98 184
July 83 1S O .32 10.87 -0.20 .083* -2.31 839 -7.69 343
Aug. 83 2.50 .36 10.97 .35 .005 - .97 1591 -7.31 578
Sept. 83 2.50 .30 9.05 1.13* .086* -3.73 1440 -7.84 572
Oct. 83 .75 .26 7.67 -1.61" - .045* 1.04 1774 3.11 639
Nov. 83 1.25 .26 7.58 - 1.54* -. 157* 3.52 2155 4.55 645
Dec. 83 .75 .26 7.73 - 1.71* - .230* 5.20 1621 7.00 437
Jan. 84 1.00 .25 7.64 - 1.79* - .333* 6.50 2290 10.28 547
Feb. 84 .50 .25 7.65 - 1.99* -SO* 8.77 4211 11.81 620
Mar. 84 .50 .25 7.24 -2.00* - .640* 9.71 8223 14.84 1037
Apr. 84 SO .25 7.11 - 1.95* - .537* 8.79 5342 13.34 845
May 84 1.oo .25 7.31 - 1.83* - .090* 2.08 939 3.36 320
~~ ~ ~

"Asterisks denote relative kurtosis and first-order autocorrelations significantly different from zero at the 10 percent significance level using a two-tailed test.
"Rule 1 is sell (buy) if current price is greater (less) than the last price. Rule 2 is sell (buy) if current price is greater (less) than the last two prices.
'These statistics were calculated using log price changes as explained in eq. (8).
 The largest price change out of the 381,956 observations was 3.5 cents in the Sep-
tember 1983 and December 1983 contracts during August 1983. Price changes greater
than a cent were rare. For 19 of the 97 months observed, no price changes were greater
than 1/2 cent (two ticks). The May 1984 contract in Table I shows the typical pattern. The
largest price changes occurred just after the open in July, August, or September. During
these months the corn crop is at critical stages of growth and information about weather
can have large impacts on price. This was especially true in 1983 when a drought was
developing in the corn belt.
Relative kurtosis, average absolute price change and standard deviation show a similar
pattern to the maximum price changes. The average absolute price change for the last
five months of the May contract was equal to the minimum price change allowed
(.25 cents). Thus, in most cases a single order is unlikely to result in more than a mini-
mum price change. Since an order may result in no price change, liquidity costs are
probably less than the minimum price change ($12.50 per contract). Thompson and
Waller (1986) obtained similar estimates of 10 dollars for cocoa and $18.75 for the lower
volume coffee contract.
Relative kurtosis tends to be negative and significant. This means that intraday price
changes are platykurtic, with fewer observations in the tails than a normal distribution.
This finding may be related to no zero price changes being included in the data set and
the truncation caused by the minimum price change.
The returns from the two naive scalping rules in Tables I and I1 show monthly average
returns per contract traded were always less than $12.50 per contract for Rule 1, which is
the rule that most closely corresponds to Working’s (1977) definition of scalping. Rule 2
had returns slightly greater than $12.50 per contract for some months. Even though
Rule 2 had greater returns per trade, it had lower total returns since it traded less than
Rule 1. Returns were higher in the four months prior to the delivery month as was the
number of trades. Thus, scalping income is much higher in these months since both re-
turns per trade and number of trades are higher. Results were similar across contracts.
But, returns to the scalping rule were higher in December and March, the two highest
volume contracts. Returns for the September contract are the lowest. Cunningham (1979)
argues that scalpers usually do not trade September contracts for corn or soybeans because
the volume is too low. Excluding September, returns for the four months prior to expira-
tion ranged from $8.44 to $9.06 for Rule 1 and from $12.80 to $15.17 for Rule 2. These

Table I1
RETURNS PER CONTRACT TRADED AND NUMBER OF
TRADES FROM SIMULATING TRADING OF TWO NAIVE
SCALPING RULES ON INTRADAY CORN PRICES
Rule 1 Rule 2
4 mo. Prior to 4 mo. Prior to
All Trades Expiration All Trades Expiration
Contract
Month $/Trade Trades $/Trade Trades $/Trade Trades $/Trade Trades

July 83 7.75 36022 9.06 22438 8.95 6322 12.80 3283

Sept. 83 4.87 18010 6.91 12782 5.75 5490 9.14 3333
Dec. 83 8.29 82158 8.44 41055 13.61 17624 15.17 9419
Mar. 83 7.19 53958 9.04 26609 9.30 11442 13.32 3777
May 83 5.58 32111 8.90 20066 4.15 7371 12.99 3049
July 84 6.45 46580 8.94 25487 7.03 9843 14.06 3978
returns are higher than the simulated returns of $4.24 for cocoa and $3.50 for coffee
found by Thompson and Waller (1986). Since returns were greater than the $1S O commis-
sion charged to most floor traders, scalping using a naive rule would have been profitable.
The returns to scalping are similar to the $10.56 per contract found by Silber using
records of a scalper who traded the New York Stock Exchange Composite Index. The
minimum price change for this contract was $25.00 per contract. Silber (1984) found
scalping returns were 0.026 percent of contract value. Working (1977) found that a
scalper in New York cotton had returns of 0.023 percent of contract value. The two naive
rules presented here have returns of about 0.06 and 0.08 percent of contract value for
Rule 1 and Rule 2, respectively. The higher percent returns found here may be because
corn is a smaller value contract and scalpers demand a return per contract traded rather
than as a percent of value. Another possibility is that simulated returns are higher be-
cause scalpers accept a smaller expected return in order to reduce risk. The distribution
of simulated returns is negatively skewed since the naive rules suffered some large losses
that a risk averse scalper probably would have avoided.
The liquidity costs for futures markets are substantially lower than the 0.298 percent to
1.74 percent of contract value estimated by Roll (1984) for stocks. Futures markets
probably have lower liquidity costs because of higher volume, but institutional factors
such as lower margin requirements and lower commission charges for futures and a com-
petitively determined liquidity cost versus one determined by a single market maker are
also probably important.
Next, hypotheses about the effects of maturity, volume, and seasonality on the standard
deviation and returns from Rule 1 are tested7 (Table 111). The trigonometric functions are
included as a proxy for the amount of information arriving to the market. More informa-
tion is expected to arrive in the summer months when the crop is in critical stages of
growth. But, the seasonality implied by the results in Table I11 are not obvious. Therefore
Table IV reports the seasonal changes implied by the estimated trigonometric functions.
The results are as expected. Price changes are larger in the summer months and returns to
scalpers are lower. A scalper would probably not follow a naive rule like the one used
here when the market is moving rapidly in response to new information, but these results
do support the hypothesis that changes in the returns to information traders are more
important in determining liquidity costs and scalping returns than shifts in the supply or
demand for scalping services.
Maturity is not significant in either equation while volume is significant in both regres-
sions.*The standard deviation decreases as volume increases. The returns per trade from
the naive scalping rule increase as volume increases. The scalping rule works best when
volume is high and there is less need to consider other types of information. This sug-
gests that the major influence of volume is reducing returns to information traders. Thus,
both scalpers and those who want to submit market orders have incentives to trade in the
high volume contracts. This may explain why so much trading is concentrated in the high
volume nearby contracts.
CONCLUSIONS
This paper sought to determine the size of liquidity costs and scalping returns in the corn
futures market and test hypotheses about the factors that influence the returns to scalpers
'Regressions were also run for returns from Rule 2, but the results were essentially the same as that for
Rule 1 and so were not included.
?his is not true, however, if the entire life of the contract is included in the regression equations. In this
case, maturity is significant in both equations and volume is only significant in the returns to scalping equation.
In addition, the elasticity with respect to maturity is higher in each model. This illustrates the importance of
following Cunningham's (1979) suggestion and only including the four months prior to the expiration month.

LIQUIDITY COSTS AND SCALPING RETURNS / 233

 Table I11
ESTIMATED REGRESSION COEFFICIENTS SHOWING THE EFFECT
OF SEASONALITY, MATURITY, AND VOLUME ON VALUES CALCULATED
FROM INTRADAY CORN FUTURES PRICES DURING THE FOUR MONTHS
PRIOR TO EXPIRATION*
Dependent Variable
Returns/Trade
Independent Standard From Scalpingb
Variable Deviation ($/Round Turn)

Intercept 7.984** 7.053**

(16.98) (12.97)
cos: -0.230 0.270
(-1.26) (1.28)
SIN, 0.781** 0.134
(4.71) (0.70)
-0.7 lo** 0.124
(-4.02) (0.61)
-0.824** 1.251
(-3.98) (5.22)
Maturityd 0.181 -0.105
(1.58) (-0.80)
Volume -0.265* 0.853**
(mil. contracts) (- 1.75) (4.86)
F-test for seasonality“ 14.84** 6.83**
R-squared 0.80 0.65
~________ ~ ~~~~~ ~ ~~ ~~_______ ~~

‘One asterisk denotes significance at the 10 percent level and two asterisks denotes significance at the
5 percent level (two-tailed test). The values in parentheses are t-values.
%e trading rule used is sell (buy) if the current price is greater (less) than the last price.
‘COS, and SIN, are cosine and sine functions with a period of i months.
dMaturity is measured as the months prior to expiration.
T h e null hypothesis of no seasonality implies that each of the four coefficients on the sine and cosine terms
are zero.

and the costs of liquidity. Intraday price data, which contained a record of every price
change, were used. No information was available on transactions which resulted in no
price change or on the size of the transactions, and thus the results should be interpreted
with some caution. Trading of two naive scalping rules was simulated to estimate the re-
turns to scalpers. The absolute value of price changes were used as the measure of liquid-
ity costs. This measure of liquidity costs was nearly equal to the minimum price change
of $12.50 per contract. But, liquidity costs could be larger for large orders, orders during
the low volume early months of trading, or for a trader who trades similarly to a large
number of other traders. Liquidity costs for the large public futures funds (Irwin and
Brorsen (1985)), for example, are likely larger.’

%orsen and Irwin (1987) report that futures funds confine over 80% of their trading to the nearby contract
because of liquidity costs. The trading record of one of these funds which was analyzed by Greer and Brorsen
(1987) shows that an order often “moves the market” in the sense that the order is often filled at two or even
three different prices with each successive price being less favorable to the fund. Greer and Brorsen (1987) also
find substantially larger liquidity costs than those reported here.

2341 BRORSEN
 Table IV
ESTIMATED SEASONAL CHANGES IMPLIED BY THE REGRESSIONS IN TABLE I11
Month Standard Deviation Returns to Scalping

($/contract)
Jan.
Feb .
- .465
- ,277
.984
1.126
Mar. - .594 .981
Apr. - .920 .770
May - .588 .537
June .480 .146
July 1.588 - .482
Aug. 1.860 -1.164
Sept. 1.054 - 1.521
Oct. -0.203 - 1.272
Nov. -0.994 -0.499
Dec . -0.940 0.394

Liquidity costs should be considered in research simulating hedging strategies. But,

liquidity costs do seem to be less important than full-price commission costs for a typical
hedger. The scalping costs for futures markets are small relative to those found for stocks
by Roll (1984). Thus, the system of open outcry and competitively determined bid-ask
spreads seems to be working well.
Seasonality, and volume were significant factors in explaining the standard deviation
and returns to a naive scalping rule while maturity was not. Seasonality is a proxy for the
amount of information arriving to the market. During the critical growth period for corn,
the scalping rule was less profitable and price changes were larger. As volume increased,
price changes became smaller and scalping became more profitable. Thus, scalping is
most profitable and liquidity costs are lowest when the amount of fundamental informa-
tion between transactions is small. This is because the return to information traders is
lower and thus both scalpers and those who want to submit market orders are better off
trading in the high volume contracts.

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LIQUIDITY COSTS AND SCALPING RETURNS / 235

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2361 B~ORSEN