How to Define Illegal Price Manipulation

The term “illegal price manipulation” is difficult to define. Current U.S. law does not explicitly define it. The finance and economics literature uses the term “manipulation” in an imprecise manner. This paper proposes that a trading strategy not be classified as “illegal price manipulation” unless the violator’s intent is to pursue a scheme that undermines economic efficiency both by making prices less accurate as signals for efficient resource allocation and by making markets less liquid for risk transfer. Since price effects are market-wide, we treat the terms “price manipulation” and “market manipulation” as synonyms. Our definition applies equally to financial and commodities markets. ∗ Kyle: University of Maryland, Robert H. Smith School of Business, 4433 Van Munching Hall, College Park, MD 20742-1815, [email protected]. Viswanathan: Duke University, Fuqua School of Business, One Towerview Drive, Durham, NC 27708, [email protected]. We thank our discussant Alex Edmans for his comments. “Pricing accuracy” means something different from the term “market efficiency.” Pricing accuracy measures the precision with which prices provide signals to encourage efficient resource allocation. Market efficiency refers to the difficulty of making trading profits on the basis of available information. In a market which is about to be cornered, high prices are consistent with market efficiency because they accurately forecast the probability of the corner, but not consistent with pricing accuracy because prices are providing signals to mis-allocate resources.