Is the Market Being Fooled? An Error-Based Screen for Manipulation

Abstract

In this paper, we develop a new screen to detect manipulation in commodities markets. If manipulation is occurring, not all of the relevant information is being filtered through the market, which means that the market is being "fooled" and its ability to forecast future prices is impaired. If futures prices are the market's estimates of future spot prices, manipulation can be expected, therefore, to result in larger first and second moments of the forecast error in those prices, controlling for other factors (not related to manipulation) that could affect risk premium. We apply our technique to the Hunt Brothers' silver manipulation episode of 1979-80. After controlling for market and macroeconomic fundamentals not affected by manipulation (but which could explain variations in risk premium), we find that the variance of the bias is significantly larger under manipulation, and the mean reverses sign consistent with backwardation.

Keywords: Manipulation, Screen, Futures Prices, Spot Prices, Commodities Markets, Forecasting Errors, Risk Premium, Basis

JEL Classification: C39, C51, C53, G19, K21, K49