Hype and Dump Manipulation

Nevzat Eren and Han Ozsoylev

No 2008fe08, Economics Series Working Papers from University of Oxford, Department of Economics

Abstract: This paper introduces signaling in a standard market microstructure model so as to explore the economic circumstances under which hype and dump manipulation can be an equilibrium outcome. We consider a discrete time, multi-period model with stages of signaling and asset trading.A single informed trader contemplates whether or not to spread a (possibly dishonest) rumor on the asset payoff among uninformed traders. Dishonest rumor-mongering is costly due to regulatory enforcement, and the uninformed traders who access the rumor can be sophisticated or naive. The sophisticated traders correctly anticipate the relationship between the rumor and the asset payoff, whereas the naive ones take the rumor at its face value as if it truthfully reveals the asset payoff. The presence of sophisticated traders puts the informed trader off from rumor-mongering, because sophisticates fully infer the asset payoff from the rumor, reducing the informational rents enjoyed by the informed trader. Nevertheless we show that it can be optimal for an informed trader to create false hype among uninformed traders provided that there is at least one naive trader in the market and the cost of dishonest rumor-mongering is not too low. The false hype allows the informed trader to sell at an inflated price or buy at a deflated one. Intense regulatory enforcement, which makes dishonest rumor-mongering very costly, may not necessarily curb hype and dump schemes. Market depth and trading volume rise with "hype and dump" while market efficiency decreases.

Keywords: Manipulation; Hype and Dump; Costly Signaling; Regulatory Enforcement; Market Depth; Trading Volume; Market Efficiency (search for similar items in EconPapers)
JEL-codes: G11 G14 (search for similar items in EconPapers)
Date: 2008-01-01
References: Add references at CitEc
Citations: View citations in EconPapers (2)

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