Market manipulation: identification, characteristics and prevention
This thesis explores an important element of market quality – fairness. Trade-based market manipulation, one of the prohibited trading behaviours in the world, is a major threat to market fairness. Manipulation can distort prices, thus reducing market efficiency and cause heavy economic losses. Manipulation also undermines investor confidence and prevents investors from participating in the market. Regulators all over the world expend significant resources in the identification, investigation and prosecution of market manipulation.
This thesis undertakes three pieces of analysis to contribute to the academic literature. This study first identifies the financial characteristics of listed companies with higher risks of manipulation. Second, this thesis explores two market protocols and their impact on manipulation. Specifically, two important design features of call auctions are analysed. First the limitation on the cancellations and modification of orders, or inflexibility; and secondly random ending times of call auctions.
The first study examines hand collected data from 66 manipulation cases announced by the China Securities Regulatory Commission between 2010 and 2019. The analysis finds that listed companies that have poor financial performance are more likely to be manipulated. Specifically, these listed companies have lower profit and current ratio, but higher leverage ratio. Moreover, by constructing a larger sample regression using high-frequency data, the results are consistent with the case tests. Accordingly, this study suggests improving the quality of listed companies and adopting more targeted supervision measures for different types of listed companies.
The second study empirically tests the effect of the trading rule reform of the closing call auction introduced by Shanghai Stock Exchange on 20 August 2018. It measures the risk of closing price manipulation by using end of day price dislocation and constructs an empirical model to compare the risk pre and post the rule reform. The study holds that the reform has effectively restrained the risk of closing price manipulation. In addition, based on examining the call auction rules adopted by major international stock exchanges, this research constructs an empirical test on the effect of different call auction mechanisms adopted by six major international stock exchanges on market manipulation risk. The results show that the inflexible call auction is more effective in reducing the risk of market manipulation. The empirical conclusions prove the effectiveness of the introduction of closing call auction on Shanghai Stock Exchange in restraining the risk of market manipulation and enriches the empirical research on inflexible call auctions.
The third study examines the effect on market efficiency and potential market manipulation of introducing a randomised call auction ending time for three equity markets. The study finds that the probability of a price dislocation at the end of the auction declines, indicating a lower risk of market manipulation. In addition, the variance ratio and market-adjusted return volatility measures decrease, suggesting a more efficient and less volatile price discovery process. The research confirms a behavioural change in order submissions by observing the timing of order entry, amendments and deletions on one of the exchanges where the order data is available. Overall, the results indicate that adding a randomised auction ending time can reduce the risk of market manipulation and improve price efficiency.
