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

This paper investigates an attempted delivery squeeze in a bond futures contract traded in London. Using 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 marked differences in settlement failure penalties 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 dates, and that exchanges mark-to-market their contract specifications more frequently, or consider a cash-settled contract on a basket of bonds.     

Alternative settlement methods and Australian individual share futures contracts

Individual share futures contracts have been introduced in Australia since 1994. Initially, the contracts were settled in cash. In 1996, cash settlement was gradually replaced by physical delivery. This study investigates the effects of the settlement method change on Australian individual stock and its futures markets. Specifically, we examine whether return and volatility of each market, correlation between the two markets, basis behavior, and hedging performance of futures markets differ across cash settlement period and physical delivery period. We find that, after the switch from cash settlement to physical delivery, the futures market, the spot market, and the basis all become more volatile. However, each individual share futures contract becomes a more effective hedging instrument. The improvement in hedging effectiveness is particularly impressive for the most recently established individual share futures contracts.     

An empirical investigation of large trader market manipulation in derivatives markets

Using account-level transaction data in options and futures markets, we investigate the existence of market manipulation, which is the ability of large traders to trade strategically, impacting prices and making abnormal profits. First, large trader’s option positions have a quantity impact on the underlying asset’s price. Second, large traders generate significantly positive alphas from trading options and futures. Among the different investor types, proprietary dealers generate the largest positive alphas. Third, these abnormal returns are consistent with strategic trading and cross-market manipulation. The evidence supports market manipulation across the options and futures markets, but not within the futures market itself.     

中国利率市场的价格发现——对国债现货、期货以及利率互换市场的研究

本文采用信息份额模型和基于向量自回归(VAR)模型的格兰杰因果检验,研究了国债现货、国债期货和利率互换三个市场之间的价格发现机制。信息份额模型表明,从整体来看利率互换相对于国债期货和国债现货都具有信息优势,而国债期货相对于国债现货具有信息优势。另外,国债期货的价格发现能力相对于另外两个市场都在随时间增强。格兰杰因果检验结果显示,利率互换在价格发现中单向引领国债期货以及国债现货,国债期货单向引领国债现货。所有结果一致表明, 利率互换和国债期货这两种利率衍生产品在引导中国利率市场价格发现中发挥了重要作用。     

Difference Systems in Financial Futures Markets

Many financial futures markets allow substitutions for the par grade of security at delivery. Substitutes are deliverable at premiums or discounts—“differences” in commodities parlance—to the futures price. The rule that establishes these differences is called a difference system. This paper characterizes financial futures market equilibrium with yield-based difference systems and investigates particular systems in use. The major finding is that currently used difference systems effectively limit deliverable supply in the futures markets and lead to futures prices which understate the cash market price of the par security.     

The Influence of Information Arrival on Market Microstructure: Evidence from Three Related Markets

This study examines the influence of information arrival on market microstructure for the MMI, NYSE, and S&P 500 stock index futures markets, with special emphasis on the effects of opening and closing of trading and expiration of contracts on price movements and trading activities. The results of the examination show that although the opening of the (MMI) futures market is associated with higher volatility, it is when the spot market opens that volatility reaches its highest level. Similarly, the closing of the futures markets, though more volatile, is not as volatile as the closing of the spot markets. Trading patterns, on the other hand, are distinct from volatility. For MMI, trading declines consistently after the close of the spot market. In contrast, the NYSE and S&P 500 continue to trade and reach a peak at the close of the futures markets. Expiration effects are evidenced by the increase in volatility and trading near the closing of the MMI and the spillover to the NYSE and S&P 500. In sharp contrast, the expirations of the NYSE and S&P 500 are only assooiated with decrease in trading, suggesting that efforts to dampen volatility by changing expiration days from Friday to Thursday and shifting settlement price from Friday close to Friday open, have been successful.     

Trading costs and price discovery

The price discovery roles of a set of related markets or securities have been investigated in many different settings where trading costs effect is often commingled with other trading arrangement factors. In Hong Kong, regular futures and mini futures contracts as well as their underlying spot asset are all traded on a same electronic trading platform. The trading arrangements thus provide us with a unique setting where we can isolate the impacts of transaction costs on price discovery. Using Hasbrouck’s (J Finance 50:1175–1199, 1995) information share approach, it is found that in Hong Kong, the regular futures contracts market plays a dominant role in price discovery while the mini futures and cash index markets play minor roles. The results in this paper provide an unequivocal support to the trading costs hypothesis.     

The equilibrium price of futures contracts: A result drawn from capital asset pricing model

A recent study shows that separation theorems in the stock and forward market literatures may not hold in an integrated financial market; therefore, the securities market may influence futures trading. This article investigates the securities market influence on the futures price. The result shows that although the futures price incorporates the investor's expectation about the future spot price, it generally is not a best estimate of the spot price. In addition, it is shown that the speculative activity can destabilize the cash market for some commodities, if initially, the underlying cash price is highly volatile.     

The Lead‐Lag Relationship Between Cash and Stock Index Futures in a New Market

This paper investigates the lead‐lag relationship in daily returns and volatilities between price movements of the FTSE/ATHEX‐20 and FTSE/ATHEX Mid‐40 stock index futures and the underlying cash indices in the relatively new futures market of Greece. Empirical results show that there is a bi‐directional relationship between cash and futures prices. However, futures lead the cash index returns, by responding more rapidly to economic events than stock prices. This speed is much higher in the more liquid FTSE/ATHEX‐20 market. Moreover, results indicate that futures volatilities spill information over to the corresponding cash market volatilities in both investigated futures markets, but volatilities in the cash markets have no effect on the volatilities of futures markets. Overall, it seems that new market information is disseminated faster in the futures market compared to the stock market. This implies that the futures markets can be used as price discovery vehicles, providing further evidence that derivatives markets contribute to completing and stabilising capital markets in Greece. A further finding of this study is that futures volume and disequilibrium effects between cash and futures prices are important variables in the explanation of volatilities in cash and futures markets.     

限制交易政策如何影响期现关系?——对股指期货价格发现功能的实证检验

本文利用2015年中国股市大幅下跌期间,对股指期货严格限制交易政策这一独特事件前后的高频数据,研究限制交易政策对股指期货与股票市场价格引导关系的影响。利用I-S模型和分位数回归方法的实证结果表明:限制交易政策实施前,股指期货对股票市场的价格影响更强,尤其表现在价格急剧下跌时期;限制交易政策显著增加了期货市场交易成本,从而降低了期货市场的信息份额,削弱了其对股票市场的价格影响,并且改变了期货价格对现货价格“助跌强于助涨”的影响模式,增强了股指期货在价格上涨时对股票市场的影响。研究结果一方面直接量化了期货交易成本变动对其价格发现功能的负面影响,另一方面也从价格引导关系的视角提供了股市危机时期股指期货限制交易政策监管效果的实证证据。     

股指期货市场操纵与价格发现功能的关系研究

股指期货市场操纵会影响股指期货市场的价格发现功能,同样地,股指期货市场的价格发现功能也会影响股指期货市场的操纵行为。本文在理论探讨的基础上,利用股指期货主力合约及对应的沪深300指数高频数据对市场操纵行为进行实证分析。研究结果表明,当操纵嫌疑只存在于期货市场时,股指期货市场的价格发现功能将会减弱;当操纵嫌疑存在于期货、现货两个市场时,股指期货市场的价格发现功能相对会增强。而且,当股指期货市场价格发现功能较强时,市场操纵的难度和成本都将下降。当前中国股指期货市场的操纵行为可能主要局限于某些个别的、离散的交易日内,系统地通过操纵现货指数来操纵期货市场的可能性较低。     

The Impact of Futures Trading on the Spot Market for Treasury Bonds

Critics of futures markets contend that futures trading destabilizes spot prices and raises price levels of the underlying treasury bonds, while the proponents claim that futures trading improves the information content and stability of spot prices. To investigate these conflicting viewpoints, this paper examines the price behavior of treasury bonds at three critical time points: a) as they enter, retain, and exit the cheapest-to-deliver status; b) as they approach the futures delivery date; and, c) as they cease to be deliverable. An empirical analysis based on a rich data set of daily bond prices over thirty-four delivery quarters reveals little support for the critics’ view of futures trading.     

Expiration day effects and market manipulation: evidence from Taiwan

In this study, we analyze the expiration day effects of index futures on the cash market in Taiwan, and find that both volatility and trading volume are higher on the final settlement days than on other trading days. We also calculate the volume of open interest for the final settlement of index futures contracts relating to different classes of traders, as well as the profits they earn from their open interest positions. We find that proprietary traders exhibit superior performance whereas foreign investors achieve the worst returns. Our empirical results support the view that the expiration day effects in the Taiwan futures market are at least partially attributable to attempts at ‘marking the close’.     

Price discovery and volatility spillovers in index futures markets: Some evidence from Mexico

This paper investigates the hypotheses that the recently established Mexican stock index futures market effectively serves the price discovery function, and that the introduction of futures trading has provoked volatility in the underlying spot market. We test both hypotheses simultaneously with daily data from Mexico in the context of a modified EGARCH model that also incorporates possible cointegration between the futures and spot markets. The evidence supports both hypotheses, suggesting that the futures market in Mexico is a useful price discovery vehicle, although futures trading has also been a source of instability for the spot market. Several managerial implications are derived and discussed.     

Relative informational efficiency of cash,futures, and options markets: The case of an emerging market

We study the lead–lag relationships among the spot, futures, and options markets on Hong Kong’s Hang Seng Index (HSI). The young options market experiences thin trading, and the option returns lag the cash index returns. The more mature futures market experiences active trading. Yet its lead over the cash index appears to be less than the counterparts in other countries. A possible reason is the dominance of a few major stocks in the index; and these stocks have symmetric lead–lag relations with the futures. Furthermore, the informativeness of the non-lasting futures and options quotations seems to depend on the market maturity.     

On the Role of Futures Trading in Spot Market Fluctuations: Perpetrator of Volatility or Victim of Regret?

We examine the role of index futures trading in spot market volatility. We use the exponential generalized autoregressive conditional heteroskedasticity (EGARCH) approach to measure volatility, analyze causality and feedback relations between volatilities in the spot and futures markets, and test various hypotheses in the context of a multivariate model that incorporates other macrostate variables. Our empirical results suggest index futures trading may not be blamed for the observed volatility in the spot market. Rather, we find stronger and more consistent support for the alternative posture that volatility in the futures market is an outgrowth of a turbulent cash market. We use the regret (cognitive dissonance) theory to explain our results.     

Valuation and Optimal Exercise of the Wild Card Option in the Treasury Bond Futures Market

The Chicago Board of Trade Treasury Bond Futures Contract allows the short position several delivery options as to when and with which bond the contract will be settled. The timing option allows the short position to choose any business day in the delivery month to make delivery. In addition, the contract settlement price is locked in at 2:00 p .m . when the futures market closes, despite the facts that the short position need not declare an intent to settle the contract until 8:00 p .m . and that trading in Treasury bonds can occur all day in dealer markets. If bond prices change significantly between 2:00 and 8:00 p .m ., the short has the option of settling the contract at a favorable 2:00 p .m . price. This phenomenon, which recurs on every trading day of the delivery month, creates a sequence of 6-hour put options for the short position which has been dubbed the “wild card option.” This paper presents a valuation model for the wild card option and computes estimates of the value of that option, as well as rules for its optimal exercise.     

Price discovery on the S&P 500 index markets: An analysis of spot index,index futures,and SPDRs

This paper investigates the price discovery function in three S&P 500 index markets: the spot index, index futures, and S&P Depositary Receipts markets. Four hypotheses regarding market structure and security design are proposed to differentiate the price discovery function performed by the three index instruments. Using matched synchronous intraday trading data, Johansen's maximum likelihood estimator is employed to disclose the cointegration relationships among the three markets. Results indicate that the three price series are a cointegrated system with one long-run stochastic trend. Estimated coefficients of the vector error correction model suggest that price adjustment takes place in the spot index market and for SPDRs, but not in the futures market. When the common stochastic trend is decomposed, it is found that the futures market serves the dominant price discovery function. The leverage hypothesis and the uptick rule hypothesis explain its superior price discovery function.     

Price Discovery Between Informationally Linked Markets During Different Trading Phases

The dynamic nature of the price information transfer when stock and futures markets switch between different price trading phases is examined. This is undertaken by decomposing Australian stock indexes and share price index futures contract data into bear- and bull-market phases and analyzing the change in the power of the bidirectional information feedback between the futures market and small, medium, and large stocks. Results support the hypothesis that the nature of the price-discovery process varies with the trading phase. In particular, during the bull phase small stocks show a marked increase in price exogeneity and futures prices contain relatively less price-sensitive fundamental information. We argue that in bull phases, futures trading becomes increasingly associated with noninformation trading such as realizing paper profits, portfolio rebalancing, and increased noise trading.     

GAMBLING, SPECULATION, AND INSURANCE: WHY THEY CONTINUE TO BE CONFUSED AND CONDEMNED

Governments and the media have often attacked financiers for “speculating” in their countries' currencies, thereby forcing them to make drastic and sometimes painful changes in monetary and fiscal policies. This article argues that such accusations have no basis in economic theory, and that “such rhetoric should be seen for what it is: an attempt by politicians and policy-makers to divert attention and blame from their own mismanagement.” More generally, the author argues that the failure of the general public to understand the social benefits of financial activies such as trading in government bonds, commodity futures, and, more recently, financial derivatives has led throughout history to “prejudice, bad laws, and bad regulations.” Much as the charging of interest and certain forms of insurance were proscribed by the medieval Church, agricultural commodity futures were attacked in the 19th century (and in much of the 20th as well) in the U.S. and elsewhere as thinly disguised forms of gambling. Moreover, the same restrictions that were imposed on gambling and futures markets during the 19th and early 20th centuries are now imposed in many Third-World countries. Instead of encouraging the use of forward markets by small producers and traders, and promoting the development of organized commodity markets and banks in local centers, most less-developed countries today support national and international “stabilization” measures such as buffer stocks and regulations like price floors, price ceilings, and crop quotas. Meanwhile, in Western nations, governments continue to accuse financial markets of “destabilizing speculation” and of a myopic obsession with short-term profitability—even as the U.S. IPO market continues to assign record values to companies that have yet to show profits. Viewed in this light, the media and regulatory assaults on the junk bond markets in the late 1980s and on derivatives in the early 1990s are only the latest in a long line of misguided attacks on financial innovation.