Microstructure-based manipulation: Strategic behavior and performance of spoofing traders

• Published in: Journal of financial markets (Amsterdam, Netherlands) Netherlands), 2013-05, Vol.16 (2), p.227-252
• Main Authors: Lee, Eun Jung, Eom, Kyong Shik, Park, Kyung Suh
• Format: Article
• Language: English
• Subjects: Microstructure-based manipulation; Pre-trade transparency; Spoofing order
• ISSN: 1386-4181; 1878-576X
• DOI: 10.1016/j.finmar.2012.05.004

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 spoofing 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, differs from previously studied forms of manipulation based on information or transactions. Roughly half of the spoofing orders were placed in conjunction with day trading. 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 extra profits. The frequency of spoofing orders decreased drastically after the KRX altered its order-disclosure rule. ► We examine a microstructure-based manipulation, a new kind of manipulation. ► Investors strategically placed spoofing orders which, given the Korea Exchange's (KRX's) order-disclosure rule at the time, created the impression of a substantial order book imbalance, with the intent to manipulate subsequent prices. ► Stocks targeted for manipulation had higher return volatility, lower market capitalization, lower price level, and lower managerial transparency. ► Spoofers achieved substantial extra profits. ► The frequency of spoofing orders decreased drastically after the KRX altered its order-disclosure rule.