Microstructure based manipulation

Abstract

We examine how investors strategically spoof the stock market by placing orders with little chance of being executed, but which mislead other traders into thinking there is an imbalance in the order book. Using the complete intraday order and trade data of the Korea Exchange (KRX) in a custom data set identifying individual accounts, we find that investors strategically placed spoof orders which, given the KRX`s order-disclosure rule at the time, created the impression of a substantial order book imbalance, with the intent to manipulate subsequent prices. This manipulation, which made use of specific features of the market microstructure, is different from previously studied forms of manipulation, based on information or transactions. Stocks targeted for manipulation had higher return volatility, lower market capitalization, lower price level, and lower managerial transparency. We also find that spoofing traders achieved substantial excess profits. The frequency of spoofing orders decreased drastically after the KRX altered its order-disclosure rule.