Hype and Dump Manipulation

43 Pages Posted: 5 Dec 2006

See all articles by Nevzat Eren

Nevzat Eren

University of Minnesota - Twin Cities - College of Liberal Arts

Han N. Ozsoylev

Ozyegin University

Date Written: November 2006

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, sophisticated trader, naive trader, market depth, trading volume, market efficiency

JEL Classification: G11, G14

Suggested Citation

Eren, Nevzat and Ozsoylev, Han N., Hype and Dump Manipulation (November 2006). EFA 2007 Ljubljana Meetings Paper, AFA 2008 New Orleans Meetings Paper, Available at SSRN: https://ssrn.com/abstract=948814 or http://dx.doi.org/10.2139/ssrn.948814

Nevzat Eren

University of Minnesota - Twin Cities - College of Liberal Arts ( email )

Minneapolis, MN
United States

Han N. Ozsoylev (Contact Author)

Ozyegin University ( email )

Kusbakisi Cd. No: 2
Altunizade, Uskudar
Istanbul, 34662
Turkey

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