Trading in Phantom Markets: Price Manipulation in an Emerging Stock Market¤

How costly is poor governance of market intermediaries? Using a unique trade level data set from the stock market in Pakistan, we ...nd that brokers when trading on their own behalf, manipulate prices and earn rates of return that are 50-90 percentage points higher than the outside investors. Neither market timing nor liquidity provision by brokers can explain the pro...tability di¤erential. Instead we ...nd compelling evidence for a speci...c trade-based “pump and dump” price manipulation scheme: When prices are low, colluding brokers trade amongst themselves to arti...cially raise prices and attract positive-feedback traders. Once prices have risen, the former exit leaving the latter to su¤er the ensuing price fall. The manipulation rents extracted by brokers from such schemes therefore suggest a political economy explanation for why reforms aimed at equity market development are actively resisted by brokers. ¤Kennedy School of Government, Harvard University; and Graduate School of Business, University of Chicago. Email: [email protected], [email protected]. We are extremely grateful to the Securities and Exchange Commission Pakistan (SECP) for providing us the data used in this paper, and to Mr. Khalid Mirza and Mr. Haroon Sharif for clarifying questions. The results in this paper do not necessarily represent the views of the SECP. We also thank Ulf Axelson, Nick Barberis, Marriane Bertrand, Gene Fama, Francisco Gomes, Pete Kyle, Raja Kali, Steve Kaplan, Owen Lamont, Tobi Moskowitz, Raghu Rajan, Jeremy Stein and seminar participants at Chicago GSB, LSE, MIT, LUMS, Michigan, NEUDC conference, and SECP for helpful comments and suggestions. All errors are our own.