Regulation and Futures Markets

Question 1

Who regulates futures markets?

Answer 1

1) Clearing house - day-to-day rules and regulations

2) CFTC (US) or SIB (UK) regulate clearing house

Question 2

What is the economic rationale for regulation?

Answer 2

1) Monopoly - Groups can act together to manipulate markets
2) Public goods - financial stability provided by futures markets
3) Externalities - markets do not trade information as: i) there is a huge cost to gathering info and not much benefit to passing on and ii) government might intervene to ensure quality of data accurate

Question 3

Define market manipulation

Answer 3

Elimination of effective price competition through domination of supply/demand and the exercise of the domination to intentionally produce artificially high/low prices

Question 4

What is the impact of manipulation?

Answer 4

1) Price doesn’t reflect supply and demnd
2) Price efficiency declines as volatility increases around amturity
3) hedging ability reduced (price discovery)

Question 5

What are futures markets susceptible?

Answer 5

1) Specific delivery date and delivery points
2) Specific good, no subsitutes
3) Trade volume is greater in futures than spot so it is easier to hide

Question 6

How does long manipulation occur?

Answer 6

1) When the cost of additional unit of commodity to deliver to deliver increases as number of deliveries increase
2) Single trader owns enough futures positions and/or enough of deliverable supply that they can demand short deliverer meet commitments

Question 7

What types of preventative regulation are there?

Answer 7

1) Position limits
2) Entry requirements
3) Emergency intervention

Question 8

What are Pirrong’s 4 criteria for punitive action?

Answer 8

1) If offence is easily detected
2) If perpetrator is wealthy
3) If they knew what they were doing
4) Administration cost of prosecution low

Question 9

What were observed effects of regulation?

Answer 9

1) Seat prices in chicago rose

2) Decreased volatility spillover onto stock markets

Question 10

Name a few cases of manipulation?

Answer 10

1) Great western Food distribution (1947)
2) Cargill Inc (1967)
3) Hunts’ Silver Corner (1989)
4) Sumitono copper (1996)
5) Dairy Farmers of America (2008)

Question 11

What are the issues with regulation?

Answer 11

1) Hard to monitor and prove
2) Expensive to prosecute
3) Screen-based and non standard trading
4) Cross-market/border links
5) large scale trading, natural dominance