Title: Sheep in wolves clothing: Using false signals of demand to execute a market power manipulation
Authors: Craig Pirrong - University of Houston (United States) [presenting]
Abstract: The most famous type of market manipulation is a corner, where a trader accumulates a futures position that exceeds the supply of the commodity at delivery points. This type of manipulation has led regulators to compare a long's position to deliverable supply to determine whether the long had manipulated. This test implicitly assumes that shorts believe a long will not consume what is delivered. This raises the question whether there may be situations in which shorts believe that a long might consume what they deliver. A signaling model is presented in which some longs place a high value on the physical commodity and consume what is delivered to them, but there are other longs who place a low value on it and will not consume it. Shorts do not know which type of long stands for delivery. A low-valuation type exploits this uncertainty to execute a manipulation by misrepresenting his demand for the commodity by offering to sell his positions at a price that equals the valuation of the high-value type. Shorts do not know his true demand, and assign some positive probability to the possibility that the long's offer price reflects his actual valuation and that he will consume the deliveries. There is a pooling equilibrium in which low-value demanders mimic high-value demanders. This allows them to liquidate some of their futures positions at an artificially high price and profit even though they lose money when they resell what shorts deliver to them.