Manipulation and the Allocational Role of Prices

Abstract

It is commonly believed that prices in secondary financial markets play an important allocational role because they contain information that facilitates the efficient allocation of resources. This paper identifies a limitation inherent in this role of prices. It shows that the presence of a feedback effect from the financial market to the real value of a firm creates an incentive for an uninformed trader to sell the firm's stock. When this happens the informativeness of the stock price decreases, and the beneficial allocational role of the financial market weakens. The trader profits from this trading strategy, partly because his trading distorts the firm's investment. We therefore refer to this strategy as "manipulation". We show that trading without information is profitable only with sell orders, driving a wedge between the allocational implications of buyer and seller initiated speculation, and providing justification for restrictions on short sales. Copyright 2008 The Review of Economic Studies Limited.

Predatory Short Selling

“…In the second stage, creditors decide whether or not to roll over their debt. As in Goldstein and Gümbel (2008), the presence of short sellers reduces price informativeness.…”

Speculation and Hedging in Segmented Markets

“…Glosten (1989), Spiegel and Subrahmanyam (1992), Dow and Rahi (2003), Goldstein and Guembel (2008) and Kyle, Ou-Yang, and Wei (2011), among others, study Kyle (1985)-type models with endogenous noise trading generated from risk-averse uninformed hedgers who hedge their endowment at University of Pennsylvania Library on April 13, 2014 http://rfs.oxfordjournals.org/ Downloaded from risk optimally. Similar formulations of hedging motives also appear in Grossman-Stiglitz (1980)-type models-for example, Duffie and Rahi (1995), Lo, Mamaysky, and Wang (2004), Watanabe (2008), Biais, Bossaerts, and Spatt (2010) and Huang and Wang (2010).…”

Beauty Contests and Irrational Exuberance: A Neoclassical Approach

“…(25) To see that this is indeed the case, note that, under any policy as in (12), the equilibrium price must satisfy p = K[9\K,uj} -tq -r p p -tkK. Equivalently, P = 1 + T" K,u>] -T -T K K (26) Next note that if the policy (to,t p ,tk-) implements the constrained efficient allocation, then (27) with coefficients (7o,7k,7w) as in Section 4 with (3q = 6$, Px = 5 X , and j3 y = 5 y , Replacing (27) into (26), one can then easily see that the policy with coefficients T = 70, tk = IK, r p = -y ul - 1. is such that p -6 -lu - 6 (34) Substituting (33) and (34) into (32) (36) into (35) …”