Market Manipulation and a Model of the United States Treasury Securities Auction Market
Posted: 13 Jul 1998
Date Written: November 1995
Abstract
This paper develops in a new framework, an equilibrium model of the U.S. Treasury Securities auction market under both discriminatory and uniform price auction rules. In the model, traders participate in forward trading of Treasury securities in a "when-issued" market before the Treasury auction. Next, bidding takes place in a Treasury auction and securities are delivered. Last, a resale market occurs where "short-cornering" and market manipulating "squeezes" can happen with rational traders. These manipulations occur in auctions by dealers who, participating in the when-issued market, use their knowledge of the net order flow to bid aggressively in the auction in order to corner the market and squeeze the shorts (from the when-issued market). This equilibrium is shown to be consistent with the abnormal price behavior of Treasury securities surrounding dealer induced squeezes. Our analysis also shows that manipulations will not occur in long-run equilibrium under uniform price auctions. Under this long-run equilibrium condition, the uniform price auction enhances social welfare by yielding greater revenue to the Treasury than does the discriminatory auction.
JEL Classification: G20
Suggested Citation: Suggested Citation