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Price Manipulation, Dynamic Informed Trading and Tame Equilibria: Theory and Computation

This paper studies a dynamic version of the model proposed in Glosten and Milgrom (1985) with a long-lived informed trader. When the same individual can buy, and then sell, the same asset, the trader may profit from price manipulation. We make a fundamental contribution by clarifying the conditions under which a unique equilibrium exists, and in what situations this equilibrium involves price manipulation. We propose a concept that we refer to as a “tame†equilibrium, and derive a bound for the number of trading rounds under (or over) which a unique equilibrium exists (or multiple equilibria exist) for a sufficiently low probability of informed trading. We characterize and compute tame equilibria. Further, we provide a necessary and sufficient condition under which manipulation arises. We contend that we can extend our analysis to a continuous-time setting and thereby provide a reference framework in a discrete-time setting with a unique equilibrium.

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Paper provided by School of Economics, University of Queensland, Australia in its series Discussion Papers Series with number 492.

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Date of creation: 16 Oct 2013
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Handle: RePEc:qld:uq2004:492
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  1. Tālis J. Putniņš, 2012. "Market Manipulation: A Survey," Journal of Economic Surveys, Wiley Blackwell, vol. 26(5), pages 952-967, December.
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  3. Bernard De Meyer, 2007. "Price Dynamics on a Stock Market with Asymmetric Information," Cowles Foundation Discussion Papers 1604, Cowles Foundation for Research in Economics, Yale University.
  4. Allen, F. & Gorton, G., 1991. "Stock Price Manipulation, Market Microstructure and Asymetric Information," Weiss Center Working Papers 21-91, Wharton School - Weiss Center for International Financial Research.
  5. Mikhail Golosov & Aleh Tsyvinski & Guido Lorenzoni, 2008. "Decentralized trading with private information," 2008 Meeting Papers 391, Society for Economic Dynamics.
  6. Lawrence R. Glosten & Paul R. Milgrom, 1983. "Bid, Ask and Transaction Prices in a Specialist Market with Heterogeneously Informed Traders," Discussion Papers 570, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  7. Pierre Collin-Dufresne & Vyacheslav Fos, 2012. "Insider Trading, Stochastic Liquidity and Equilibrium Prices," NBER Working Papers 18451, National Bureau of Economic Research, Inc.
  8. Gur Huberman & Werner Stanzl, 2004. "Price Manipulation and Quasi-Arbitrage," Econometrica, Econometric Society, vol. 72(4), pages 1247-1275, 07.
  9. Archishman Chakraborty & Bilge Yilmaz, . "Informed Manipulation," Rodney L. White Center for Financial Research Working Papers 07-00, Wharton School Rodney L. White Center for Financial Research.
  10. Merrick, John Jr & Naik, Narayan Y. & Yadav, Pradeep K., 2005. "Strategic trading behavior and price distortion in a manipulated market: anatomy of a squeeze," Journal of Financial Economics, Elsevier, vol. 77(1), pages 171-218, July.
  11. Jordan, Bradford D. & Jordan, Susan D., 1996. "Salomon brothers and the May 1991 Treasury auction: Analysis of a market corner," Journal of Banking & Finance, Elsevier, vol. 20(1), pages 25-40, January.
  12. Back, Kerry, 1992. "Insider Trading in Continuous Time," Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 387-409.
  13. Bruno Biais & David Martimort & Jean-Charles Rochet, 2000. "Competing Mechanisms in a Common Value Environment," Econometrica, Econometric Society, vol. 68(4), pages 799-838, July.
  14. Ozsoylev, Han N. & Takayama, Shino, 2010. "Price, trade size, and information revelation in multi-period securities markets," Journal of Financial Markets, Elsevier, vol. 13(1), pages 49-76, February.
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  16. Calcagno, Riccardo & Lovo, Stefano M., 1998. "Bid-Ask Price Competition with Asymmetric Information between Market Makers," Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) 1998012, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
  17. Jarrow, Robert A., 1992. "Market Manipulation, Bubbles, Corners, and Short Squeezes," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 27(03), pages 311-336, September.
  18. Koski, Jennifer Lynch & Michaely, Roni, 2000. "Prices, Liquidity, and the Information Content of Trades," Review of Financial Studies, Society for Financial Studies, vol. 13(3), pages 659-96.
  19. Vitale, Paolo, 2000. "Speculative noise trading and manipulation in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 19(5), pages 689-712, October.
  20. Allen, Franklin & Gale, Douglas, 1992. "Stock-Price Manipulation," Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 503-29.
  21. Krinsky, Itzhak & Lee, Jason, 1996. " Earnings Announcements and the Components of the Bid-Ask Spread," Journal of Finance, American Finance Association, vol. 51(4), pages 1523-35, September.
  22. Shino Takayama, 2010. "A dynamic strategy of the informed trader with market manipulation," Annals of Finance, Springer, vol. 6(2), pages 287-294, March.
  23. Riccardo Calcagno & Stefano Lovo, 2006. "Bid-Ask Price Competition with Asymmetric Information between Market-Makers," Review of Economic Studies, Oxford University Press, vol. 73(2), pages 329-355.
  24. Duffie, Darrell, et al, 1994. "Stationary Markov Equilibria," Econometrica, Econometric Society, vol. 62(4), pages 745-81, July.
  25. Felixson, Karl & Pelli, Anders, 1999. "Day end returns--stock price manipulation," Journal of Multinational Financial Management, Elsevier, vol. 9(2), pages 95-127, March.
  26. I. Krinsky & J. Lee, 1996. "Earning Announcements and the Components of the Bid-Ask Aspread," Quantitative Studies in Economics and Population Research Reports 313, McMaster University.
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