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

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  • Merrick, John J.
  • Naik, Narayan Y.
  • Yadav, Pradeep K.

Abstract

This paper investigates the trading behavior of major market participants during an attempted delivery squeeze in a bond futures contract traded in London. Using the cash and futures trades of dealers and customers, we analyze their strategic trading behavior, price distortion and learning in a market manipulation setting. We argue that the marked differences in the penalties for settlement failures in the cash and futures markets create conditions that favor squeezes. We recommend that regulators require special flagging of forward term repurchase agreements on the key deliverables that span futures contract maturity date, and exchanges remove the conditions that create squeeze incentives in the first place, e.g. mark-to-market their contract specifications much more frequently, or consider redefining the contract to be cash-settled on a basket of traded bonds.

Suggested Citation

  • Merrick, John J. & Naik, Narayan Y. & Yadav, Pradeep K., 2004. "Strategic trading behavior and price distortion in a manipulated market: Anatomy of a squeeze," CFR Working Papers 04-07, University of Cologne, Centre for Financial Research (CFR).
    • Handle: RePEc:zbw:cfrwps:0407
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    More about this item

    Keywords

    Price manipulation; Futures markets; Squeeze;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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