The stock market has been transformed during the last 25 years. Human suppliers of liquidity like the NASDAQ dealers and NYSE specialists have been replaced by algorithmic market making; stocks that once traded on a single venue now trade across twelve exchanges and a multitude of alternative trading systems. New venues like dark pools, and new participants like high‐frequency traders, have emerged to take on prominent roles. This new market has had more than its share of controversy and regulatory scrutiny, particularly in the wake of Michael Lewis’s bestseller Flash Boys. In this article, the authors analyze five of the most controversial new market practices, including various high‐frequency trading strategies and dark pool activities. They set out a simple conceptual framework based on adverse selection and agency problems, and apply that framework to assess the welfare effects of each of the five practices. While much that is criticized is indeed objectionable, other controversial practices are much more complex than popularly imagined and may in fact be socially desirable. They conclude by evaluating a range of potential reforms to equity market structure.
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More than 80 years after US federal law first addressed stock market manipulation, there is still dispute about manipulation law’s foundational principles; this chapter aims to provide clarity by offering an analytical framework for understanding a specific manipulation. There has been a sharp split among the federal circuits concerning manipulation law’s central question: Can trading activity alone ever be considered illegal manipulation? Economists and legal scholars do not agree on whether manipulation is possible in principle, let alone on how to address it properly in practice. The framework offered by this chapter aims to help clarify federal law and may guide regulators in successfully prosecuting financial law’s most intractable wrong. We draw on the tools of microstructure economics and the theory of the firm to provide an analysis of a particular form of manipulation, identify who is harmed by it, and evaluate the social welfare effects.
Three maJOr banks have now admitted that their emp loyees manipulated worldwide interest rates tlu·ough the London lnterbank Offered Rate (Libor), the most widely used interest rate index. Libor is the interest rate term fo r trill ions of dollars of swaps and loans, and its manipulation may have been used to extract billions o f dollars. These allegations come just as commodities manipulation law has been dramatically reformed and the Commodity Futures Trading Commission (CFTC) given vast new reg ulatory powers. T his Aliicle provides the first extended, scholarly analysis of the CFTC's new anti-manipulation rules. We consider the difficulty the rules address: Commodities manipulation c laims have tradition all y faced nearly insuperable obstacles to success in prosecuting manipulations like that of Libor. We then analyze the new rules, including their extension of the CFTC's powers to cover the swap market. The new rules appropriately lower the standards of pleading and proof, and yet the breadth of the new rules invites abuse. Both to implement the new rules and to prevent overuse, we argue for more elaborate, sophisticated, and creative economic analysis than ever before. We provide a wide-ranging overview of empi1ical too ls for assessing manipulation claims, w hile re-engaging a decades-old debate on the place of empiricism in the laws of evidence and intent. We provide detailed
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