Manipulation and Information Acquisition∗

I analyze the behavior of an agent (the manipulator) who makes announcements based on his private information in order to maximize the profit from short-term trades. Truthful announcement strategies can be supported with positive probability but only if investors have another source of information in addition to the manipulator’s announcement and/or if manipulation is occasionally punished. It is shown that the manipulator benefits from announcing/trading on more regulated markets with better informed investors, because both help the manipulator commit to announce more truthfully. The presence of a manipulator increases price efficiency and decreases risk premium, even if the manipulator manipulates the announcement. Therefore, regulation to prevent manipulation is only beneficial if it forces the manipulator to announce more truthfully, and not if it forces the manipulator to stop announcing. I also analyze how the presence of the manipulator impacts investors’ decisions to purchase information. Some investors substitute the costly information for the manipulator’s announcement, even though that decreases the manipulator’s incentive to announce truthfully. Nevertheless, price efficiency improves and risk premium decreases with the presence of the manipulator. EFM classification: 350 ∗I am grateful to Burton Hollifield for his support and helpful discussions. This paper also benefited from the discussion with Bryan Routledge, Rick Green and the seminar participants at Tepper Business School. †ISCTE Business School, Av. Forças Armadas, 1649-026 Lisbon, Portugal. Phone: +351 21 790 39 16. E-mail: [email protected]