FUTURES COMMITMENTS AND EXCHANGE RATE VOLATILITY Bahram Adrangi and Arjun Chatrath* INTRODUCTION This study examines the relationship between exchange rate variability and the number of contracts held by three major groups of futures traders. The study is motivated by the inability of prior research on the futures trading ö exchange rate variability relationship to provide specific answers as to whether certain groups of traders destabilize spot markets. Such answers are thought to be of great interest to market observers, regulators and governments concerned with promoting price stability. There have been numerous calls for further regulation of futures markets, even while the debate over the impact of futures trading continues. 1 There is relatively little evidence on whether or not the level of trading activity in currency futures affects spot exchange rate behavior. Clifton (1985) finds that volume of trading activity in the currency futures market is significantly correlated with exchange rate fluctuations in the interbank foreign exchange market. Grammatikos and Saunders (1986) indicate a bi- causal relationship between futures trading volume and futures currency prices. More recently, Chatrath, Ramchander and Song (1996) demonstrate that futures trading activity leads to conditional variance in exchange rates. The above studies employ aggregate futures activity measures and are unable to test for the relationship between the futures commitments of groups of traders (hedgers, speculators, etc.) and exchange rate variability. The current investigation employs data compiled from the Commodity Futures Trading Commission’s (CFTC) Commitment of Traders (COT) report which provides a periodic breakdown of the positions of commercial traders (large hedgers), non commercial traders (large speculators) and small traders. Figure 1 presents these commitments in four major currency markets sampled monthly since 1983. It can be seen that while hedgers make up the largest class of traders, the positions of small traders and speculators have together often eclipsed those of hedgers. 2 Such disaggregated open interest Journal of Business Finance & Accounting, 25(3) & (4), April/May 1998, 0306-686X ß Blackwell Publishers Ltd. 1998, 108 Cowley Road, Oxford OX4 1JF, UK and 350 Main Street, Malden, MA 02148, USA. 501 * The authors are from the School of Business Administration, University of Portland. (Paper received January 1997, revised and accepted October 1997) Address for correspondence: Bahram Adrangi, School of Business Administration, University of Portland, 5000 N. Willamette Blvd., Portland, Oregon 97203, USA. e-mail: adrangi@up.edu.