Is Stock Manipulation Bad? Questioning the Conventional Wisdom with Evidence from the Israeli Experience

Omri Yadlin


The conventional wisdom is that any trading scheme that is not for investment purposes but, rather, for the purpose of inflating or deflating the market price, namely, manipulation, is fraudulent. This paper treats manipulation as a form of communication between the manipulator and the market. As with any communication, it may sometimes be fraudulent, but often it is based on the manipulator’s knowledge, or genuine belief, that a certain stock is being traded at a discount (or premium). Under the assumptions of the CAPM, such an informed party should use this information to trade for investment purposes only, but liquidity and risk constraints, which are ignored by the CAPM, often do not allow him to invest; instead these constraints force him to bid the market up (or down). The manipulator’s effect on the market arouses analyst attention and induces the market to update its evaluation of the firm’s value. The more liquid the market, the faster the market updates its evaluation of the firm’s value, and thus the greater the value to the manipulator if his scheme is based on information.

I support this theoretical claim with an empirical study of stock manipulation indictments brought by the Israeli Securities Agency during the last decade. The study treats each indictment as a competition between two rival analysts: the Agency, which recommends a “hold” at the pre-manipulation price and a “sell” at the post-manipulation price, and the manipulator, who recommends a “buy” at the pre-manipulation price and a “hold” at the post-manipulation price. Examining the long-run performance of the forty-five stocks that were the subjects of the indictments, I find that investors could gain by following the advice of the Agency. However, the long-run performance of the twenty-two most liquid stocks shows that these stocks experienced a significant positive abnormal return. This finding provides support for my claim that information is a driving force behind many manipulative schemes, especially those that are conducted in liquid markets.

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