A blog on financial markets and their regulation
High Frequency Manipulation at Futures Expiry
February 16, 2014Posted by on
My colleagues, Prof. Sobhesh Kumar Agarwalla and Prof. Joshy Jacob and I have a working paper on “High Frequency Manipulation at Futures Expiry: The Case of Cash Settled Indian Single Stock Futures” (also available at SSRN).
Some extracts from the abstract and the conclusion:
In 2013, the Securities and Exchange Board of India identified a case of alleged manipulation (in September 2012) of the settlement price of cash settled single stock futures based on high frequency circular trading. This alleged manipulation exploited several interesting characteristics of the Indian single stock futures market: (a) the futures contract is cash settled, (b) the settlement price is not based on a call auction or special session, but is the volume weighted average price (VWAP) during the last half an hour of trading in the cash market on the expiry date, and (c) anecdotal evidence suggests that the Indian market is more vulnerable to circular trading in which different entities associated with the same person trade with each other to create a false market.
We demonstrate that the combination of cash settlement with the use of a volume weighted average price (VWAP) to determine the settlement price on expiry day makes the Indian single stock futures market vulnerable to a form of high frequency manipulation that targets price insensitive execution algorithms. This type of manipulation is hard to prevent using mechanisms like position limits, and therefore it is necessary to establish a robust program to detect and deter manipulation.
We develop an econometric technique that uses high frequency data and which can be integrated with the automated surveillance system to identify suspected cases of high frequency manipulation very close to the event. Human judgement then needs to be applied to identify cases which prima facie justify detailed investigation and possible prosecution. Our results suggest that high frequency manipulation of price insensitive execution algorithms may be taking place. However, successful manipulation of the settlement price is relatively rare with only one clear instance (the September 27, 2012 episode) and one (milder) parallel.
Finally, the use of the volume weighted average price (VWAP) to determine the cash settlement price of the futures contract might require reconsideration.