A pragmatic evaluation of the interconnection between currency futures return volatility, open interest and volume

Abstract

In an efficiently functioning market, the exchange rate and return from the currency futures contract should be perfectly contemporaneously correlated. In this article, the authors investigated the interconnection between volatility and trading activity (open interest and volume) during January 2012 to March 2020 in Indian currency futures market. Data on three variables are used: trade settlement rates, open interest, and trading volumes for each one of the currency futures contracts. The paper found the corroboration of time-varying volatility, which exhibits high persistence and predictability in the Indian futures market. The results imply that the speculative activities, as proxied by the volumes, tend to increase the futures volatility from the GARCH (1,1) model and trading volumes have a positive relationship with volatility, while open interests have a negative relationship with volatility. The ramifications imply that futures volatility from the GARCH (1,1) model increases based on speculative activities which are proxied by the volume. Thus, Open interests have a negative impact with volatility, but trading volumes have the exact opposite relationship.

Keywords

• currency futures
• volatility
• volume
• and open interest