The effect of settlement rules on the incentive to Bang the Close

Abstract

Closing prices on financial exchanges are often used as reference prices in other contracts. As such, the robustness of the process determining closing prices is an important feature of exchanges. This paper examines whether the 2012 change in the Chicago Board of Trade's (CBT) closing price procedure made reference prices more robust, especially regarding potential manipulation. We propose a theoretical model exploring incentives to manipulate reference prices under two alternative closing price regimes. We test several predictions of the model using a proprietary data set comprised of individual transactions in CBT corn futures, and find empirical support for these predictions.