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Applied Economics
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On measuring speculative and hedging activities in

futures markets from volume and open interest data
a a
Julio J. Lucia & Angel Pardo
a
Facultad de Economía, Department of Financial Economics, University of Valencia, Avda
de los Naranjos s/n, 46022 Valencia, Spain
Published online: 10 Jan 2008.

To cite this article: Julio J. Lucia & Angel Pardo (2010): On measuring speculative and hedging activities in futures markets
from volume and open interest data, Applied Economics, 42:12, 1549-1557

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 Applied Economics, 2010, 42, 1549–1557

On measuring speculative and

hedging activities in futures markets
from volume and open interest data
Julio J. Lucia and Angel Pardo*
Facultad de Economı´a, Department of Financial Economics, University of
Valencia, Avda de los Naranjos s/n, 46022 Valencia, Spain
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This article provides a critical assessment of the line of research that

measures speculative and hedging activities in futures markets from
volume and open interest data. It makes several contributions. First,
a detailed theoretical analysis of the measures proposed in the previous
literature as proxies for speculative activity clarifies the circumstances in
which they fail, as well as the assumptions that have to be made, when they
are used as intended. Second, we propose a new way of combining the
volume and the open interest figures, which provides additional informa-
tion regarding the type of trading activity that takes place in the market on
a given date. Finally, we analyse empirically the basic statistical properties
of all the ratios when they are applied to real data for some of the stock
index futures contracts most actively traded in the world. This empirical
analysis shows the diverse behaviour of the ratios when they are applied to
a common sample of real data, which confirms our previous theoretical
findings. Our contributions should be taken into account when any of the
measures is used as a proxy for the relative importance of speculative
demand in empirical analyses.

I. Introduction position-takers (this group of traders includes the

so-called day traders, who hold their positions for less
In the literature of derivative markets, market than one trading day). The understanding of the
participants are traditionally classified as either trading purposes that underlie the trading behaviour
hedgers or speculators. In conventional terms, of market participants may shed some light on a
hedgers engage in derivative trading so as to variety of important theoretical discussions and
manage a risk exposure. Thus, a necessary condition practical issues.1
to be a hedger is to have a spot (or forward) This article contributes to the line of research that
commitment that involves a risk exposure. On the tries to identify who trades futures from objective
contrary, speculators trade derivatives without market activity data that is readily available in every
such risk exposure and thus they are outright derivative market in the world, namely, the volume

*Corresponding author. E-mail: [email protected]

1
For instance, the distinction between hedging and speculation lies at the core of the long-lasting controversy regarding
the Keynes’ normal backwardation hypothesis in futures markets. Also, in practice, it is widely accepted that both hedgers
and speculators are needed for a contract to reach a true success.
Applied Economics ISSN 0003–6846 print/ISSN 1466–4283 online ß 2010 Taylor & Francis 1549
http://www.informaworld.com
DOI: 10.1080/00036840701721489
 1550 J. J. Lucia and A. Pardo
of trading and the open interest.2 The daily trading volume and open interest figures, which not only
volume simply accounts for the amount of trading helps to understand the drawbacks of the usual ratios
activity that has taken place in a specific contract on as measures of speculation activity, but also provides
a trading date. On the contrary, the daily open additional information regarding the type of trading
interest figure determines the number of outstanding activity that takes place in the market on a given date.
contracts at the end of a trading day; i.e. the number Finally, we analyse empirically the basic statistical
of contracts that have been entered into but not yet properties of all the ratios when they are applied to
liquidated. Since the seminal papers by Rutledge real data for some of the stock index futures contracts
(1979), Leuthold (1983) and Bessembinder and most actively traded in the world. This empirical
Seguin (1993), there is a convention that the daily analysis shows the diverse behaviour of the ratios
trading volume primarily proxies movements in when they are applied to a common sample of real
speculative activity, whereas the daily open interest data. This result should be taken into account when
variable captures hedging activities in futures and any of them is used as a proxy for the relative
options markets, since open interest excludes by importance of speculative demand in empirical
definition all intraday positions taken by day traders, analyses.
most of whom are inspired by speculative motives.
In essence, the distinction between speculative and
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hedging positions is assumed to lie in the length of the

holding period. Interestingly, there is compelling
II. Speculative-hedging Demand Ratios
empirical evidence available that seems to confirm
that hedgers tend to hold their futures market
Definitions and basic relationships
positions longer than speculators.3
Based on these general ideas, Garcı́a et al. (1986) All the ratios defined below are based on two
and ap Gwilym et al. (2002) proposed to combine observable variables: the volume of trading and the
both series of data into specific ratios, which were open interest. The (daily) trading volume counts the
claimed to reflect more accurately the relative number of contracts that have been traded in a
importance of the speculative behaviour in the trading day. However, the open interest counts the
market. Since then, other authors have used the number of contracts outstanding at the end of a
proposed ratios as a proxy of the relative importance trading day. The open interest thus equals the
of the speculative demand in derivatives markets for number of outstanding long positions (or equiva-
empirical analyses with diverse objectives (see lently, short positions) at the end of a day. The open
Hagelin (2000), Corkish et al. (1997) and Kim interest in a given contract increases whenever neither
(2005), among others).4 Additionally, the ratios of the two traders involved in a contract trade is
facilitate the comparisons across different contracts closing out a position. It decreases whenever both
(defined by both their underlying assets and their parties are closing out a position. Finally, it remains
time-to-maturity periods). the same provided that only one of the two traders
This article is aimed at providing a critical is closing out a position (i.e. one trader replaces
assessment of this approach. It makes several another, or takes his position).
contributions. First, a detailed theoretical analysis To be precise, the volume of trading, denoted Vt, is
of the measures proposed in the previous literature as thus a flow variable measured over period t, whereas
proxies for speculative activity clarifies the circum- the open interest, OIt, is a stock variable measured at
stances in which they fail, as well as the assumptions the end of period t. The change in the open interest
that have to be made, when they are used as intended. over period t can be written: OIt ¼ OIt  OIt  1 (by
Second, we propose a new way of combining the convention, OI1 ¼ OI1, with t ¼ 1 being the first
2
Another way of approaching this issue has been the elaboration of surveys aimed at clarifying the type of use (if any) made
by a target group of potential users of derivatives. Finally, another source of information that has been used by a number
of researchers of the US futures markets is the CFCT Commitments of Traders reports. This approach has been put into
question many times from diverse perspectives (for instance, see Peck (1982), and Ederington and Lee (2002)).
3
Ederington and Lee (2002), for instance, in their study of the energy market show that while floor traders were the most
active, turning over 19% of their positions each day, the refiners’ turnover was only 9%. Also, Wiley and Daigler (1998,
pp. 99–100) show that, at least for financial futures, on average, commercials keep their positions significantly longer than do
the noncommercials (under the classification of the CFCT Commitment of Traders).
4
Several authors have combined the volume and open interest figures in empirical analyses with other purposes. For example,
Black (1986) applied both variables in order to measure the success or failure of futures contracts. The volume to open interest
ratio has also been used as measure of liquidity by Holland and Vila (1997).
 On measuring speculative and hedging activities 1551
trading day). Thus, OIt is a difference of two stock above-mentioned ratios as speculation-hedging
variables and it is defined over period t. measures. It is defined by the following formula:
In this section, every observational period t (with
OIt
t ¼ 1, 2, . . . , T) is considered to be a trading day (i.e. a R3t 
Vt
day when the market is open for trading in a given
futures contract). This implies that Vt  0 and OIt  0, This ratio has no dimension, and can take any value
for every t. Also, notice that OIt 2 ½Vt , Vt . In ranging from  1 to þ 1, R3t 2 ½1, þ 1. To see why
words, the maximum value of the change in the open this must be the case, recall that the change in the
interest over a period is given by the value of the open interest over period t is bounded below by Vt
volume of trading over the same period (this happens and above by Vt. A positive number indicates that the
when the parties involved in every contract traded number of opened positions is greater than the
over the period have all taken new positions in those number of liquidated positions. A negative number
contracts). Also, the minimum value of the change in indicates just the opposite. The ratio is undetermined
the open interest is minus the trading volume (this when Vt ¼ OIt ¼ 0.
happens when all the parties involved in every
contract traded over the period have closed out Comparison of the ratios as speculation-hedging
positions that had been taken in previous periods). measures
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Garcı́a et al. (1986) suggested that the total volume

of contracts traded in a period relative to the size of Broadly speaking, when the ratios R1t and R2t are
open positions at the end of the period reflects (the used as measures of speculative and hedging activity,
it is assumed that an increase (a decrease) in the
relative importance of) the speculative behaviour in
volume of trading relative to the open interest
a given contract. The volume-to-open-interest ratio
indicates that there is either an increase (a decrease)
(R1t, henceforth) is defined as:
in the activity of the speculators or a decrease (an
Vt increase) in the activity of hedgers. In other words, in
R1t 
OIt both cases, the distinction between speculative and
hedging positions lies in the length of the positions’
If it is multiplied by 100 it is interpreted as a
holding period. This general assumption underlies the
percentage per period (one trading day). R1t can take
analysis of any of the three ratios, when used as
any positive real number, including zero, and takes
relative speculation measures. Additionally, recall
the value plus infinity whenever the open interest
that, roughly speaking, the lower the relative impor-
equals zero. The ratio is undetermined when tance of the speculative demand is, the lower the value
Vt ¼ OIt ¼ 0. of the R1t and R2t ratios and the higher the value of
ap Gwilym et al. (2002) modified the relative R3t should be. This would imply a positive correlation
measure mentioned earlier. They considered that the between R1t and R2t as well as a negative correlation
daily change in open interest reflects more accurately between any of these two ratios and the R3t. Finally,
the activity of hedgers than the level of open interest, notice that these basic relationships can be blurred by
because the daily change informs of net positions the fact that, since the ratios are computed in a
being opened and/or closed each day and held different way, they are not expected to respond exactly
overnight. For this reason, they proposed calculating in the same way to the behaviour of the main
a new speculative ratio as the volume divided by the component variables (volume and open interest).
absolute value of the change in the open interest. As the three ratios are considered as measures of
To be precise, the ratio of volume to absolute change the relative importance of the speculative activity in a
in open interest (denoted R2t) is defined as: futures contract, their detailed analysis is now carried
Vt out. A simulated example of the daily trading activity
R2t  in a fictitious market will help to clarify the main
jOIt j
issues of our exposition (Table 1). The example
It is dimensionless, and if it is multiplied by 100 it is covers the relevant possible cases with respect to the
interpreted as a percentage. It can take any strictly main variables that enter into the ratios’ formulas
positive real number (it takes the value plus infinity (see the second column).
whenever the change in the open interest equals zero). To begin with, consider the circumstances under
The ratio is undetermined when Vt ¼ OIt ¼ 0. which the ratios defined above do not provide a value
Finally, we define the ratio of the change in open that could be meaningfully used as a proxy for the
interest to volume (or R3t, henceforth), which relative importance of speculation. These include the
will help us to clarify the drawbacks of using the cases when either the ratios are undetermined or they
 1552 J. J. Lucia and A. Pardo
Table 1. Illustrative trading activity example

Trading Outstanding positions

Day Circumstance Buyer Seller Long Short Vt OIt R1t R2t R3t
1 AA BB AA BB 2 2 1 1 1
2 V¼jOIj BB AA 2 0 2/0 1 1
OI¼0
3 V¼jOIj AAA BBB AAA BBB 3 3 1 1 1
OI>0
4 V¼0 AAA BBB 0 3 0 0/0 0/0
OI¼0
5 V¼jOIj CCA BDB AAACCA BBBBDB 3 6 1/2 1 1
OI>0
6 V¼jOIj BB AA ACCA BBDB 2 4 1/2 1 1
OI<0
7 V>0 EF FE ACCA BBDB 2 4 1/2 2/0 0
OI¼0
8 V>0 AG CC AAAG BBDB 2 4 1/2 2/0 0
OI¼0
9 V>jOIj GGGA DDDB AAGGGG BDBDDD 4 6 2/3 2 2/4
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OI>0
10 V>jOIj HDD IGG AAGGH BDBDI 3 5 3/5 3 1/3
OI<0
11 Before closing time I H AAGG BBDD 1 4
11 After closing time BBDD AAGG 4 0
Notes: This table simulates the trading activity for a sequence of consecutive days in a fictitious futures market. In columns
3–6, each one of the nine traders involved in the example is represented by a distinctive capital letter, from A to I. In columns
3 and 4, each one of the capital letters indicates a single contract, which is negotiated by a trader as indicated. In columns 5
and 6, each capital letter indicates a position in one contract, held at the end of a day by a trader as indicated. The activity of
the final (eleventh) day has been split in two: the first row registers the activity resulting from the trading activity, and the
second represents the cancellation of outstanding positions by the clearing house, once the final settlement has taken place. Vt
stands for volume of trading (in number of contracts), OIt is the open interest, OIt is the change in the open interest, and
R1t, R2t and R3t are the three ratios defined in the main body of the text.

take an infinite value. Recall that indeterminacies Next, we will consider some important specific
occur when Vt ¼ OIt ¼ 0 for R1t (this would happen drawbacks of each ratio, assuming that they are used
on the third day in the example in Table 1, if no as intended, i.e. as measures of the relative impor-
contract were traded on this date), and when tance of the speculative activity in a contract. Firstly,
Vt ¼ OIt ¼ 0 for both R2t and R3t (this happens consider the R1t ratio. The main inconvenience of it is
on the fourth day in the example). These circum- that it relates a flow variable that refers to a specific
stances will mostly occur in reality during the first day t, Vt, to a stock variable measured at the end of
days of trading of any given contract, and they can be the same day, OIt, whose value does not depend
avoided altogether by considering only those days exclusively on the behaviour of traders on such a
with a strictly positive volume of trading in empirical date. Accordingly, the behaviour of the ratio depends
analyses. Provided that Vt > 0, however, the ratio R1t not only on the behaviour of traders on the
can provide an infinite value when the open interest observational day but also on the whole past history
becomes zero (day two in the example), while the of the contract up to the same day. That is why in the
same happens to R2t when the daily change in the example in Table 1, for instance, the R1t ratio takes
open interest is zero (days 7 and 8 in the example). the same value in four consecutive days (days 5–8),
The first case is expected to take place mostly during regardless of the quite different trading behaviour of
the first days of trading of a contract, whereas the traders during those days. Hence, R1t turns out to
second could occur more frequently much later, be inadequate for following speculation activity of
however.5 Again, for empirical purposes, these traders over time.
circumstances must be avoided by restricting the Secondly, consider the R2t ratio. It avoids the
sample of data accordingly. problem mentioned above by replacing the open
5
For a real example of the importance of this second possibility, see Table 2 in the next section.
 On measuring speculative and hedging activities 1553
interest at the end of the day, used by the R1t ratio, term position. The same happens to R3t, (that is why
with the change in the open interest during the day. each ratio takes the same value on day number 7 and
R2t is able to discriminate between day trades (short- day number 8 in the example).6 This implies that both
term speculation), which are reflected in the volume ratios assimilate any surrogation to day trades
of trading but not in the daily change in the open (increasing the importance of the speculation or
interest, and the newly taken positions that are held reducing the importance of long term trading). In
overnight, which equally modify the trading volume other words, when used as speculation measures,
and the change in the open interest (as an example of both ratios assume that any surrogation is a day
this, R2t takes the value 1 on days 3 and 5 in Table 1, trade. Unfortunately, there is no way of discriminat-
because on these days all the traded contracts imply ing between both circumstances from volume and
newly taken positions that are held overnight). open interest data only.
Additional day trades would clearly imply a larger
value for R2t. Again, this is related to the main
assumption that underlies the use of the ratio R2t as a
speculative measure, i.e. speculators do not hold open III. Empirical Analysis of Speculation-
positions overnight. Nevertheless, consider what hedging Measures
happens if all the contracts traded in a given day
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are due to day trades (this is the case on day 7 in the Data description
example). Then, as mentioned above, R2t takes an
infinite value, which implies that this day must be For the empirical analysis, we have selected three of
excluded from the analysis. the most actively-traded stock index futures contracts
Additionally, R2t fails to properly account for a in the world. The stock index futures contracts
couple of circumstances that may occur, which limits considered are: the Standard & Poor’s 500 futures
its application as a speculative measure unless the contract (S&P 500), the Nikkei 225 futures contract
researcher is willing to accept two additional assump- (Nikkei) and the Eurex DAX Index futures contract
tions. First, due to the absolute value function that (DAX). All the contracts considered have several
accompanies the change in the open interest, R2t is common features: they have well-developed spot
not able to discriminate between positive changes in markets as well as a remarkable tradition in trading
the open interest (when the newly taken positions that stock index futures contracts; futures prices are
are held overnight outnumber the liquidation of old quoted in index points, and the value of the contracts
positions) and negative changes (when the opposite is the futures price times a multiple (this is USD 250
case takes place). This implies that when R2t is for S&P 500, JPY 1000 for the Nikkei and EUR 25,
interpreted as a speculation measure, both cases are for the DAX); finally, all contracts have deliveries
assimilated. In other words, it is assumed that all the in the usual March-June-September-December quar-
changes in the open interest, either positive or terly cycle, and all of them are settled in cash.
negative, imply that the opening of new positions The entire sample of data used in this article
outnumber the liquidation of old positions (that is consists of the daily figures of trading volume and
why, in the example in Table 1, R2t takes the same open interest for the futures contracts with the three
value, one, in days 3 and 5, which are days with all underlying indexes mentioned above and with matur-
newly taken positions, as well as in day 6, which is a ity dates in the months of March, June, September
day with all liquidating positions). Notice that this and December between March 2000 and December
drawback can be circumvented by taking out the 2006. Thus, the sample comprises the trading activity
absolute value function from the ratio. This is what is data of 84 (3 times 28) futures contracts. Based on
done in R3t (that is why it takes a different value on this data, the three ratios (R1t, R2t and R3t) were
days 3 and 5, on one side, and on day 6, on the other, computed daily for each one of the 84 contracts (to
in the example in Table 1). Thus, when the liquida- avoid indeterminacies, only those days with a strictly
tion of long term positions outnumbers the opening positive volume of trading were considered; in other
of new positions this is considered as an increase in words, every observational period t refers to an actual
the speculative activity (a reduction in the relative trading day). Finally, for homogeneity and liquidity
importance of the hedging activity) by this ratio. reasons, we decided to concentrate on ratios for the
Second, R2t is unable to discriminate between day first-to-maturity and the second-to-maturity series of
trades and those transactions that simply imply that futures contracts. To this aim, we constructed two
one agent is substituted for another in their old long series of ratios. The first one was made up of the
6
Also, notice that R2t takes an infinite value in purely subrogating days.
 1554 J. J. Lucia and A. Pardo
Table 2. Liquidity of the first and second to delivery futures contracts

Average volume per day Days with no

(number of observations) Average OI per day change in OI (%)

First Second First Second First Second

S&P 500 60172.43 (1760) 16305.42 (1755) 518782.65 82108.79 0.057 1.254
Nikkei 46289.12 (1721) 1518.66 (1440) 230767.45 26335.61 0.232 14.028
DAX 93023.61 (1747) 6119.29 (1747) 221909.33 21728.89 0.630 2.803
Notes: This table presents the daily average volume and the daily average open interest, both measured in number
of contracts. The number of observations appears in parentheses below. The last two columns show the
percentage of days in which the open interest is the same in two consecutive days.

Table 3. Speculation-hedging demand ratios

R1t R2t R3t

First Second First Second First Second

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S&P 500 Mean 0.148 0.104 88.344 5.746 0.070 0.414

Median 0.118 0.058 19.291 1.682 0.025 0.545
Var. coef. 0.770 1.106 5.902 3.861 3.189 1.137
Nikkei Mean 0.211 0.030 92.171 4.201 0.007 0.379
Median 0.198 0.004 20.141 1.720 0.022 0.373
Var. coef. 0.327 2.094 8.400 2.176 29.031 1.372
DAX Mean 0.453 0.174 125.839 11.552 0.000 0.252
Median 0.406 0.056 36.239 3.324 0.005 0.210
Var. coef. 0.602 10.304 4.714 2.862 240.611 1.653

Notes: This table reports the mean, median and variation coefficient (SD divided by the mean value) for the speculation-
hedging demand ratios (R1t, R2t and R3t), for the daily series of the first and second to maturity futures contracts, for each
underlying index (S&P500, Nikkei and DAX).

ratios for the nearby futures contract. The second independently for the first and second to maturity
series took the ratios for the next futures contract. series in Table 3.
In the end, the observational period runs from 10 Several comparisons can be carried out based on
December 1999 to 15 December 2006, both for the the summary statistics reported in Table 3. To begin
first-to-delivery series and for the second-to-delivery with, the mean values of the ratios for the first and
series. Table 2 summarizes the liquidity features of the second-to-maturity series can be compared. The
both the nearby and the next futures contract series. contracts with the longest time to maturity show
It also reports the number of observations (trading the lowest mean values of R1t and R2t, as well as the
days) included in every series.7 highest mean values of R3t. Both results could be
interpreted in the same way: the first-to-maturity
contracts seem to attract more speculation activity
Empirical comparison of speculation-hedging (i.e. the second-to-maturity contracts seem to be used
measures more for hedging activities than the first-to-maturity
contracts).
Now, we perform a comparative analysis of two The mean values of the ratios can also be compared
series for each of the three speculative-hedging ratios across underlying indexes. For the first maturity,
in order to test if they provide similar information both R1t and R2t ratios take their lowest values for
when applied to real data. The mean, median and the S&P 500 underlying index, while the R3t ratio
variation coefficient of the daily ratios are reported takes its highest value for the DAX index. Also, for
7
The last trading day for the S&P 500 and the Nikkei futures contracts is earlier than the final settlement date. Therefore, data
of volume of trading and open interest are available for every trading day. However, this is not the case for DAX futures
contracts. Hence, in the DAX case, the ratios cannot be computed on the last trading day. For that reason, we assumed that
all the positions that remained open are closed on the last trading day (i.e. OIT ¼ 0).
 On measuring speculative and hedging activities 1555
Table 4. Pair-wise cross-correlation coefficients for the ratios

First maturity Second maturity

R1t  R2t R1t  R3t R2t  R3t R1t  R2t R1t  R3t R2t  R3t
S&P 500  0.233(**) 0.097(**) 0.4 18(**) 0.235(**) 0.418(**) 0.747(**)
p-Value 0.000 0.000 0.000 0.000 0.000 0.000
N. obs. 1758 1759 1758 1732 1754 1732
Nikkei  0.005 0.052(*) 0.215(**) 0.049 0.351(**) 0.478(**)
p-Value 0.821 0.030 0.000 0.086 0.000 0.000
N. obs. 1716 1720 1716 1229 1431 1229
DAX  0.066(**) 0.184(**) 0.114(**) 0.029 0.160(**) 0.397(**)
p-Value 0.007 0.000 0.000 0.226 0.000 0.000
N. obs. 1710 1721 1710 1692 1741 1692
Notes: This table reports the Spearman’s rank-order correlation coefficients between any two speculation-hedging demand
ratios (R1t, R2t and R3t) for the series of the first and second to maturity contracts, for each underlying index (S&P500,
Nikkei and DAX).  stands for the Spearman’s rank cross-correlation coefficient, p-value is the critical significance
probability level (null hypothesis: correlation equal to zero), and N.obs. is the number of observations. One and two asterisks
denote significance at the 5% and 10% levels respectively.
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the second maturity, both R1t and R2t take their correlation coefficients for R1t–R3t is particularly
lowest values for the Nikkei index, while R3t takes its relevant to the aim of this article since, if both ratios
highest value for the S&P 500 index. Thus, according provided similar information on the evolution of the
to the R1t and R2t ratios, the futures contracts on the relative importance of speculative activity, a signifi-
S&P 500 and Nikkei index attracted the lowest cant and negative cross-correlation between them
speculative demand, respectively, for the nearby and should be found. These results do not come at a
the next futures contracts, among all the indexes surprise: they are simply the consequence of the
considered. The R3t ratio, however, provides different disadvantages of using the R1t and R2t ratios for
results indicating that the Nikkei and the S&P 500 discriminating between speculating and hedging
futures contracts are used more for hedging activities that were pointed out in the previous section.
for the first and second to maturity futures contracts, Nevertheless, the negative cross correlations between
respectively. R2t and R3t indicate that both ratios provide similar
Next, we test formally whether the three ratios information regarding the evolution of the relative
offer similar information about the evolution of importance of the hedging demand over time in the
speculation/hedging demand over time. To be precise, second-to-maturity contracts, despite the fact that
for each underlying index, we perform a comparison R2t is not able to discriminate between newly taken
of the ordering over time that is implied by the daily positions that are held overnight and the liquidation
values taken by each pair of ratios. To this aim, we of old positions. This seemingly contradictory result
have calculated the Spearman cross correlation is due to the fact that the majority of days that
coefficient that takes into consideration the ranks of comprise the second-to-maturity sample are in fact
the values of two series for each trading day. Table 4 days with R3t strictly greater than zero, i.e. days
reports the pair-wise cross-correlation coefficients during which the number of newly taken positions
between the speculation-hedging demand ratios. that are held overnight is greater than the number of
Firstly, as far as the first maturity is concerned, it is liquidated positions. Indeed, the percentages of such
not possible to reach a general conclusion with respect days over the total sample are, respectively, 82,
to either the sign or the significance of the cross 63 and 75% for futures on S&P 500, Nikkei 225
correlation coefficients. Secondly, the results for the and DAX.
second maturity are somewhat different, however. On In summary, the results in Table 4 remind us of the
one hand, the correlation coefficients R1t–R2t provide dangers of using the R1t and R2t ratios for analysing
again a diversity of results. On the other hand, the the evolution of the speculative-hedging demand
cross correlation coefficients for R1t–R3t are positive during the last weeks of the life of a futures contract,
and significant whereas the cross correlations between since these days are usually characterized by the
R2t and R3t are all negative and significant. cancellation of positions, which are mistakenly taken
Overall, no general comparative conclusion can be to be newly-taken long-term positions by these ratios.
reached. Furthermore, the result of the positive cross Furthermore, they also suggest that the use of the
 1556 J. J. Lucia and A. Pardo
R1t ratio for analysing longer to maturity contracts of the holding period to discriminate between speculative
(second maturity) should be avoided. Finally, the and hedging activities. To be precise, the main assump-
high correlation between R2t and R3t when applied to tion that underlies the use of the ratios previously defined
longer to maturity contracts indicates that both ratios in the literature as speculative measures is that spec-
provide closer results in this case. This conclusion, ulators do not hold open positions overnight. In other
however, does not take into account that R2t cannot words, these ratios concentrate on the day-trade
be calculated when the open interest remains the same speculation.
as the day before, and this may be an important Additionally, we show that the traditional hedging-
limitation for empirical analyses. A zero change in the speculative measures present some specific theoretical
daily open interest happens rarely in the first maturity drawbacks (i.e. specific assumptions that are made
but, as we can see in Table 2, the percentages of to use the measures as intended) that make them
occurrence are relevant in the second maturity.8 inappropriate at least under some circumstances. For
Interestingly, other authors who have previously one thing, the volume-to-open-interest ratio turns out
used the R1t and R2t ratios when analysing speculative- to be inadequate for following the behaviour of traders
hedging demand have obtained contradictory results as over time, since its behaviour does not depend solely
well. For instance, ap Gwilym et al. (2002) applied on the behaviour of traders on the observational day
alternatively both ratios to the analysis of the spec- but also on the whole past history of the contract up to
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ulative-hedging demand for the FTSE 100, Long Gilt that day. The ratio of volume to absolute change in
and Short Sterling futures contracts. The comparison open interest assumes that all the changes in the open
of their results for each ratio across underlying assets interest, regardless of them being positive or negative,
turned out to be inconclusive (ap Gwilym et al., 2002, imply that the opening of new positions outnumber
p. 12). This was expected given our previous theoretical the liquidation of old positions.
analysis and confirms its empirical importance. We proposed a new related measure which circum-
vents some of the drawbacks of the previous measures.
In particular, it discriminates between those days when
the newly taken positions that are held overnight
outnumber the liquidation of old positions and those
IV. Final Remarks
when the opposite case takes place. A careful
examination of this measure, however, reveals that
In this article, we make a critical assessment on
the degree of speculation in derivatives markets
hedging-speculative demand measures obtained from
cannot be neatly determined, since it is impossible to
volume and open interest data. The main attraction
discriminate between day trades and subrogating
of these measures, compared to other alternatives, is
trades from volume and open interest data only.
that they are based on data that is available in every
Furthermore, by using data on some of the most
organized derivatives market.
important equity index futures traded in the world,
This advantage comes at the expense of several
we perform a comparative analysis for each of the
assumptions that are carefully explained for the first
three speculative-hedging ratios in order to test if they
time in this article. Broadly speaking, under this
provide similar information when applied to real
approach for measuring the relative importance of the
data. In general, our results warn against using
speculative/hedging activities in a certain futures con-
traditional measures for analysing either the first or
tract, the distinction between speculative and hedging
the second-to-delivery contracts.
positions is based on the length of the holding period.
Thus, any position held for a long period of time is
considered to be a hedging position regardless of its
objective and other related aspects such as the existence Acknowledgements
of a spot commitment. Additionally, arbitrage positions Financial support provided by the Instituto
are considered to be nonspeculative positions. Though Valenciano de Investigaciones Económicas (IVIE),
some available empirical evidence clearly suggests that Cátedra Finanzas Internacionales-Banco Santander,
hedgers tend to hold their positions for longer periods as well as the Spanish DGICYT and FEDER (under
than speculators, which could (at least partially) sustain the projects CGL2006-06367/CLI and SEJ2006-
this approach, the problem lies in the a priori definition 15401-C04-04/ECON) is gratefully acknowledged.
8
As reported in Yang et al. (2004, 2005), the open interest series is typically nonstationary (or integrated of order one), which
suggests that only the first difference of open interest would be appropriate. By contrast, the volume series is still stationary
while it is highly autocorrelated. Thus, R3t may also be motivated from the perspective of time series analysis. We thank an
anonymous referee for bringing this point to our attention.
 On measuring speculative and hedging activities 1557
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