Review of Quantitative Finance and Accounting, 10 (1998): 285–302 © 1998 Kluwer Academic Publishers, Boston. Manufactured in The Netherlands. Volume andVolatility in Foreign Currency Futures Markets RAMAPRASAD BHAR Faculty of Business, School of Finance and Economics, University ofTechnology, Sydney, PO Box 123, Broadway NSW 2007, Australia A. G. MALLIARIS Walter F. Mullady, Sr. Professor of BusinessAdministration, Department of Economics, Loyola University of Chicago, 820 N. Michigan Avenue, Chicago, Illinois 60611 Abstract. In this paper we propose and test several hypotheses concerning time series properties of trading volume, price, short and long-term relationships between price and volume and the determinants of trading volume in forcign currency futures. The nearby contracts for British Pound, Canadian Dollar, Japanese Yen, German Mark and Swiss Franc are analyzed in three frequencies i.e. daily, weekly and monthly. We find supportive evidence for all the five currencies that the price volatility is a determinant of the trading volume changes. Furthermore, the volatility of the price process is a determinant of the unexpected component of the changes in trading volume. Also, there is a significant relationship between the volatility of price and the volatility of trading volume changes for three of the five currencies in the daily frequency and for one currency in the monthly frequency. Key words: Volume, volatility, currency 1. Introduction Most economic reports published by the futures exchanges and regulatory agencies use volume data to measure the growth or decline of the futures contracts. Also, as exchanges research for the possible introduction of a new type of futures contract, the potential futures volume of trade in such a contract receives primary attention as a proxy for the contract’s liquidity. Furthermore, volume data are used to measure shifts in the compo- sition of futures markets, as can be illustrated by the phenomenal growth in the contract volume of financial futures compared to agricultural futures. In addition to exchanges and regulatory agencies being interested in the behavior of the volume of trading, traders themselves pay attention to trading volume. Low volume, usually implies that the market is illiquid and the bid/ask spread will tend to be large, resulting in high price volatility. Such a market will discourage hedgers, but may benefit speculators. On the other hand, high trading volume contributes to high liquidity and the bid/ask spread will tend to be small, resulting in low price variability. Hedgers prefer low day to day volatility while speculators usually do not because low volatility reduces speculators’ profits. Kluwer Journal @ats-ss5/data11/kluwer/journals/requ/v10n3art3 COMPOSED: 02/06/98 8:17 am. PG.POS. 1 SESSION: 6