Can Position Limits Restrain 'Rogue' Trading?

45 Pages Posted: 18 Jan 2011 Last revised: 26 Oct 2012

Date Written: February 3, 2011

Abstract

This paper studies the imposition of position limits on commodity futures from the perspective of curbing excessive speculation and thus manipulation. We present a simple General Equilibrium model in a static Rational Expectations framework and agent heterogeneity to illustrate that excessive speculation is foolhardy, as it serves to enrich other agents at the expense of the speculator. Position limits, on the contrary, are not only superfluous, but also counter-productive, as they exacerbate the deterioration of the equilibrium to lower levels of pareto-efficiency with increasing market power. Position limits not only reduce social welfare but also cannot restrain market manipulation.

Keywords: Constrained Optimization, Dodd-Frank Financial Reform Act, Marshallian Cross, Normal Backwardations, Rational Expectations, Winner’s Curse

JEL Classification: D40, D53, D58, D74, D91, G12, G13, N20

Suggested Citation

Ebrahim, Muhammed Shahid, Can Position Limits Restrain 'Rogue' Trading? (February 3, 2011). Journal of Banking and Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1742450 or http://dx.doi.org/10.2139/ssrn.1742450

Muhammed Shahid Ebrahim (Contact Author)

Durham Business School ( email )

Mill Hill Lane
Durham, Durham DH1 3LB
United Kingdom

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