dERIVATIVES MARkET AbUSES
ike any tool, derivatives are subject to mis- use and abuse. Two widespread concerns are “manipulation” and “excessive speculation.” e former term is employed far too promiscuously, but derivatives markets can be manipulated. In contrast, excessive speculation is a far more dubi- ous concept. L
First consider “manipulation.” e abandon with which this term is used is best illustrated by the words of a Texas cotton broker testifying before the Senate in 1928: “e word ‘manipulation’ . . . in its use is so broad as to include any operation of the cotton market that does not suit the gen- tleman who is speaking at the moment”(United States Senate, 1928). at said, there are certain kinds of conduct that are abusive and fairly called manipulative in the sense that they cause market prices to deviate from their competitive values.
e most common, and historically important
kind of manipulation is a market power manipu- lation, also known as a corner or squeeze.3 In a corner, a single trader or colluding group of trad- ers accumulates a long forward position that is larger than the amount of the commodity that can be supplied at the competitive price. For instance, a trader may purchase 20 million bushels of
soybean futures when there are only ve million bushels of soybeans available in the delivery loca- tion at the competitive price. Additional supplies can be brought to the delivery location, but this involves diverting soybeans from other markets, and this diversion is costly.
e large “long” can present the “shorts” who
have sold the 20 million bushels of futures with a choice: they can incur the cost of diverting soybeans from other markets, or buy back their obligations to deliver at a premium above the competitive price that is slightly below this cost of diversion. If the cost of diversion is suciently high, the large long can extract a healthy premi- um from the shorts. Indeed, the large long will typically take delivery of more than the ve mil- lion bushels available in the delivery market, in order to require the sellers to make even more inecient diversions at even higher costs in or- der to extract an even higher premium from the remaining sellers. is causes the price of the ma- nipulated future to rise precipitously relative to the prices in other locations, and relative to the price for delivery at subsequent dates.
Once the corner is over, the large long is likely to release the excessive supplies into the market,
See Pirrong (1996) for an extended treatment of the subject.
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