Behavior Based Manipulation

46 Pages Posted: 11 Nov 2008

See all articles by Chunsheng Zhou

Chunsheng Zhou

Peking University - Guanghua School of Management - Finance

Jianping Mei

Cheung Kong Graduate School of Business

Date Written: October 2003

Abstract

If investors are not fully rational, what can smart money do? This paper provides an example in which smart money can strategically take advantage of investors behavioral biases and manipulate the price process to make profit. The paper considers three types of traders, behavior-driven investors who have two behavioral biases (momentum trading and dispositional effect), arbitrageurs, and a manipulator who can influence asset prices. We show that, due to the investors behavioral biases and the limit of arbitrage, the manipulator can profit from a "pump and dump" trading strategy by accumulating the speculative asset while pushing the asset price up, and then selling the asset at high prices. Since nobody has private information, manipulation investigated here is completely trade-based. The paper also endogenously derives several asset pricing anomalies, including the high volatility of asset prices, momentum and reversal.

Suggested Citation

Zhou, Chunsheng and Mei, Jianping, Behavior Based Manipulation (October 2003). NYU Working Paper No. FIN-03-028, Available at SSRN: https://ssrn.com/abstract=1299470

Chunsheng Zhou

Peking University - Guanghua School of Management - Finance ( email )

Beijing, 100871
China
8610-62768188 (Phone)
8610-62768266 (Fax)

Jianping Mei

Cheung Kong Graduate School of Business ( email )

1017, Oriental Plaza 1
No.1 Dong Chang'an Street
Beijing
China
010-81588858 (Phone)
100738 (Fax)

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