Implied Matching Functionality in Futures Markets

01 November 2011
By Dr. James Overdahl

One of the more difficult challenges faced by exchanges is balancing the needs and interests of different segments of the market. One example is the introduction of implied matching functionality, a mechanism that allows exchanges to replicate certain market-making functions within their own matching engines. Some market participants have welcomed this innovation, while others have questioned its value in liquid markets. In this article from Futures Industry, NERA Industry Affiliate Dr. James Overdahl examines the impact of implied matching functionality on two specific futures contracts. Dr. Overdahl, whose research was sponsored by the FIA Principal Traders Group, analyzes the impact using five measures of market quality and finds that, in these two instances, market quality improved when the exchanges turned off their implied matching functionality. The study also finds that futures volume, an important measure of market health, increased during these periods, even after controlling for other potential explanatory variables. Finally, an examination of the order books for calendar spreads fails to yield a meaningful result as to whether market quality improved or declined when matching functionality was turned off.