Strategic trading behavior and price distortion in a manipulated market: an anatomy of a squeeze

Merrik, Jr J J, Naik, N and Yadav, P K (2002) Strategic trading behavior and price distortion in a manipulated market: an anatomy of a squeeze. Working Paper. London Business School Centre for Hedge Fund Research and Education Working Paper.

Abstract

This paper investigates the trading behavior of major market participants during and attempted delivery squeeze in a bond futures contract traded in London. Using the cash and futures trades of dealers and customers, it provides empirical evidence on the strategic trading behavior of market participants in a market manipulation setting. It shows how learning takes place in the marketplace and how squeezes are accompanied by severe price distortions and market depth erosion. It also shows how the marked differences in the penalties for settlement failures in the cash and futures markets created conditions that favor squeezes. To minimize such incidents, it recommends that exchanges marktomarket the specifications of their contracts more frequently, and that regulatory reporting requires flagging of possession oriented trades like forward term repos that straddle the futures contract delivery period.