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Behavior Based Manipulation: Theory and Prosecution Evidence

50 Pages Posted: 15 Nov 2003  

Jianping Mei

New York University (NYU) - Department of Finance

Guojun Wu

University of Houston; China Academy of Financial Research (CAFR)

Chunsheng Zhou

Peking University - Guanghua School of Management - Finance

Date Written: April 7, 2004

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 are less willing to sell losers than to sell winners (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 here is completely trade-based. The paper also endogenously derives several asset-pricing anomalies, including excess volatility, momentum and reversal. As an empirical test, the paper presents some empirical evidence from the U.S. SEC prosecution of "pump-and-dump" manipulation cases that are consistent with our model.

Keywords: Manipulation, behavioral finance, loss aversion

JEL Classification: G12, G18

Suggested Citation

Mei, Jianping and Wu, Guojun and Zhou, Chunsheng, Behavior Based Manipulation: Theory and Prosecution Evidence (April 7, 2004). Available at SSRN: https://ssrn.com/abstract=457880 or http://dx.doi.org/10.2139/ssrn.457880

Jianping Mei

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0354 (Phone)
212-995-4221 (Fax)

Guojun Wu

University of Houston ( email )

220F Melcher Hall
Houston, TX 77204-6021
United States
713-743-4813 (Phone)
713-743-4789 (Fax)

HOME PAGE: http://www.bauer.uh.edu/wu

China Academy of Financial Research (CAFR)

1954 Huashan Road
Shanghai P.R.China, 200030
China

Chunsheng Zhou (Contact Author)

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

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

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