What do you do when the markets are down?

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...

Comments

[dave]

Stop wondering, boys on the street are taking a rip like everyone else. Cayne lost a billion, rightfully so. Typical MD has 75-85% of his net worth in company stock, excluding his home. They were not selling at the top, they are bloodied.

[robertdfeinman]

A (Pakistani) commentator on the BBC mentioned that the reason for having a stock exchange - allowing firms to raise capital - was not be fulfilled in this case.

There have been no IPO's in the recent past, just speculation.

I wonder about the entire stock model, many successful firms do all their financing through borrowing and retained earnings. Why issue stock at all and dilute control?

The only reasons I can see is that the founders want to cash out and that the firm isn't of high enough quality to be able to obtain additional debt financing.

If banks won't lend you money why is the public willing to buy shares?

You can't cheat an honest man.

[Tord Steiro]

Dani.

Interesting you mentioned it. I have always wondered about the incentives given by stock options as reward to company officers. It gives them a strong incentive to inflate the value of the firm prior to their stock releases, and then come up with bad news in the aftermath to readjust the value of the firm.

[Yang]

Is it the same for Chinese stock market? It has been down for more than 50% since last year...

[bob2]

" . . analyzed finely disaggregated trading data from the Karachi Stock Exchange."

can you do this for the nyse? wouldn't surprise me if you came up with the same result

[ali sohail]

i wonder why this comes as a surprise? maybe for the international community, but surely not for any local. its a long known fact, that the KSE is dominated my a handful few! and players have been living by-it in good times, soo why not live by-it in bad times!

but more importantly, the current backlash is a result of the on-going economic gloom, which in the case of Pakistan is far-far deeper than the international subprime crisis!

[happyjuggler0]

Dani,

Pump and dump is illegal in the US and the SEC assiduously follows up on it.

Additionally, dave is right, insiders invariably take a bath when their company stock gets pummeled.

You've been in the People's Republic of Cambridge too long. Time to venture into a locale where everyone doesn't belong to the same party.

Paranoid ramblings outside your area of competence does a disservice to your more credulous readers who take you at your word.

[dani rodrik]

I must admit i am getting a bit paranoid, although i am sure it is not from spending too much time in PRC. Pump and dump by the way is illegal everywhere, yet it happens. It clearly was taking place in the MBS market and hurt the less informed investors.

[internet stranger]

My friend's old boss made nearly a billion dollars doing something similar at the CBOT in the '80s and '90s. He would lure traders in by flooding the market with bids. Then he'd sell into the buying frenzy. It got easier when the market went fully electronic.

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"In other words, a casino where the house holds all the good cards."

Isn't this always the case? I guess we shouldn't be surprised. Why shouldn't it be the same when it comes to pump & dump and insider privilege?

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The aim in Pakistan should be to strengthen the Karachi stock exchange and let its economy grow so that the stocks have sufficient depth that it can not be manipulated by a hand ful of operators. Indian stock market has also gone through a number of such instances and post liberalisation since 1991; it has given sufficient teeth to SEBI to crack a whip and keep the evil elements at bay. Regards
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