Was There Front Running During the Ltcm Crisis?

45 Pages Posted: 9 Jun 2003

Date Written: February 2003


This paper uses a unique dataset of audit trail transactions to examine the trading behavior of market makers in the Treasury bond futures market when Long-Term Capital Management (LTCM) faced binding margin constraints in 1998. Although identities are concealed in the dataset, I find strong evidence that during the crisis market makers in the aggregate engaged in front running against customer orders from a particular clearing firm (coded "PI7") that closely match various features of LTCM's trades through Bear Stearns. That is, market makers traded on their own accounts in the same direction as PI7 customers did, but one or two minutes beforehand. Furthermore, a significant percentage of market makers made abnormal profits on most of the trading days during the crisis. Their aggregate abnormal profits, however, were more than offset by abnormal losses realized after the private sector recapitalization of LTCM. Moreover, I show that before the rescue, a market maker's cumulative abnormal profit was positively correlated both to her tie as contra party with PI7 and to the intensity of her front running, but these relationships turned negative after the rescue. The overall evidence suggests that the recapitalization plan effectively relaxed LTCM's binding constraints and therefore reversed the profitability of front running.

Keywords: strategic trading, financial crisis, margin constraints, trading behavior, market microstructure

JEL Classification: E44, G10, G14

Suggested Citation

Cai, Fang, Was There Front Running During the Ltcm Crisis? (February 2003). Available at SSRN: https://ssrn.com/abstract=385560 or http://dx.doi.org/10.2139/ssrn.385560

Fang Cai (Contact Author)

Federal Reserve Board ( email )

Office of Financial Stability Policy and Research
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Washington, DC 20551
United States
202-452-3540 (Phone)
202-263-4850 (Fax)

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