A Dynamic Model of Futures Manipulation with Incomplete Information

This paper investigates the susceptibility of a futures market to manipulation in a twoperiod model with imperfect information and delivery-settled contracts. A large trader is assumed to have private information on his own type, while other traders' information regarding the large trader's identity is imperfect. Under certain mild assumptions, the model shows that a “corner’ or ‘squeeze’ can occur in equilibrium in a market even with strategic and dynamic trading and derives the sufficient conditions for the existence as well as non-existence of manipulation trading strategies. However, the ability of the large trader to manipulate is limited to a certain degree by other traders’ learning that helps detect the presence of a manipulator in the market and risk associated with manipulative strategies. The paper thus suggests an explanation of the possibility of manipulation occurrence, but the probability of manipulation may be relatively low in practice even if the market is highly liquid and with inelastic deliverable supply. It also provides a rationale for futures regulation by improving market transparency, or/and by assigning certain discretionary power to regulators.