Essay On Market Manipulation

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Uses of futures contract highlight the importance of existence of future markets. However, from the beginning, manipulation is rampant in a futures market (Markham, 1991). Manipulation is blamed since it disturbs two primary functions of futures market, which are risk transfer and price discovery. Manipulation distorts price discovery by forcing improper motive other than legitimate demand and supply. As a result, manipulation reduces the efficiency in futures market. Regulators, therefore, are set to prevent the spread of manipulation but it turned out that the regulators were not able to stop the manipulation. The main reason for unsuccessfulness was that neither regulations nor acts have clear definition of manipulation. The most frequently discussed among the market manipulation is “long” market power manipulation also known as a “corner” or a “squeeze” (Pirrong, 2010). These occurs when a trader buy a vast number of future contracts. The trader, therefore, is able to influence the price artificially through controlling supply of the commodity of the future contract. This could affect to short sellers. In the futures market, the shorts sell more contracts than quantity available that actually can be delivered at maturity. It is because the contracts are used as hedgers and speculators to transfer risks. These contracts can be offset between the shorts and longs. The short have to either provide the commodity or pay differences between spot price and futures price at maturity unless the contracts are offset between the long and the short. However, if the large long acts like a monopolist through controlling over the supply, the shorts would be cornered and pay distorted amount to the monopolist, meaning that artificial price w... ... middle of paper ... limited level of commodity that non-hedgers can hold in the month of supply up to 25 percent. This could prevent market power manipulation such as the corner. When a trader buys large quantity of derivatives so taking large position, the trader is able to exert his power to move price as his power would be increased with his position.Thus this rule restricts position held by the trader as well as ability to manipulate. Furthermore, this prevention helps to make the futures market more efficient. (Gwilym and Ebrahim, 2013).On the other hand, Pirrong (2007) agreed to a certain extent but Pirrong argued that the speculative position limit had a negative effect on market efficiency as it ‘actually reduce welfare’. As speculators are restricted in quantity, hedgers are not able to transfer price risk to speculators and speculators are not able to absorb the price risk.

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