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Spot Market Power and Future Market Trading

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  • Stephen Shore
  • Alexander Muermann

    ()

Abstract

When a spot market monopolist participates in the futures market, he has an incentive to adjust spot prices to make his futures market position more pro.table. Rational futures market makers take this into account when they set prices. Spot market power thus creates a moral hazard problem which parallels the adverse selection problem in models with inside information. This moral hazard not only reduces the optimal amount of hedging for those with and without market power, but also makes complete hedging impossible. When market makers cannot distinguish orders placed by those with and without market power, market power provides a venue for strategic trading and market manipulation. The monopolist will strategically randomize his futures market position and then use his market power to make this position pro.table. Furthermore, traders without market power can manipulate futures prices by hiding their orders behind the monopolist.s strategic trades.

Suggested Citation

  • Stephen Shore & Alexander Muermann, 2005. "Spot Market Power and Future Market Trading," FMG Discussion Papers dp531, Financial Markets Group.
  • Handle: RePEc:fmg:fmgdps:dp531
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    File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmgdps/dp531.pdf
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    Cited by:

    1. Widede Labidi & Sami Mensi, 2015. "Does Banking Market Power Matter on Financial (In)Stability? Evidence from the Banking Industry MENA Region," Working Papers 908, Economic Research Forum, revised May 2015.
    2. World Bank, 2009. "Land Reform, Rural Development, and Poverty in the Philippines : Revisiting the Agenda," World Bank Other Operational Studies 18545, The World Bank.
    3. Stahn Kerstin, 2011. "Changes in Import Pricing Behaviour: Evidence for Germany," Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik), De Gruyter, vol. 231(4), pages 522-545, August.

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