In Pakistan you storm the stock exchange, smash windows and wreck the furniture.
The story is actually a bit more complicated than that. Stock prices have been on a continuous slide in the Karachi stock exchange, and are down 38 percent from April. The angry investors apparently wanted a halt in trading, which the exchange officials denied.
Pakistani investors have good reasons to feel that the markets are manipulated. My colleague Asim Khwaja and his co-author Atif Mian came up with a remarkable result when they analyzed finely disaggregated trading data from the Karachi Stock Exchange. They found that when brokers trade on their own account they make net returns that are 50-90 percent higher than those reaped by outside investors.
Neither market timing nor liquidity provision by brokers can explain this profitability differential. Instead we find compelling evidence for a specific trade-based ‘‘pump and dump’’ price manipulation scheme: When prices are low, colluding brokers trade amongst themselves to artificially raise prices and attract positive-feedback traders. Once prices have risen, the former exit leaving the latter to suffer the ensuing price fall. Conservative estimates suggest these manipulation rents can account for almost a half of total broker earnings.
In other words, a casino where the house holds all the good cards.
Until recently, I would have assumed that this kind of manipulation occurs only in the under-developed, poorly governed financial markets of poor nations. But after everything that we have been learning in the wake of the sup-prime crisis, I wonder...