iquidity" in futures markets is a generally accepted term for the relative "L ease of entry into and exit from market commitments. Price distortions may occur when markets are illiquid, forcing traders to pay premiums or accept discounts in order to establish or close out futures positions. Two related questions become apparent when dealiig with the liquidity concept What criteria are to be used to measure liquidity, and what level of liquidity is considered optimum. In this analysis two measures of liquidity are considered, and the levels of liquidity forthcoming under specific market conditions are discussed.
Conceptually, liquidity could be measured in terms of some weighting of price quotes. In this case, the index would be based on market performance. For example, Powers (1979, p. 32) discusses the merits of using the spreads between bid and asked prices as input data for calculating a liquidity index. The bid and asked prices represent traders' assessment of the market place. An alternative method for dealing with the liquidity measure would be to turn to the structure of the market, using trading data. This article is directed to the latter alternative, utilizing data on hedging (h), speculative (s) commitments, and the volume (u) of trading.' See Peck for a discussion of the liquidity probIems associated with evaluating the importance of speculators to futures liquidity (1980, p. 1M3).
In the following analysis, an index of liquidity is developed and factors leading to adjustments in the index are evaluated. A futures trading model showing the 'A portion of the total futures commimenb are classified aa nonreported, hence, h and s are not diectly identifiable. The fdotring procedure wan used for allocating the nonreported commitments:
where rh is the reported hedge, tr is the total reported, nr L nonreported. See Ward and Behr (1982) for a detailed dmssion of this procedure. This article is Florida Agriculture Experimental Stetion No. 4360.