The regulation of trade-based manipulation

We examine a model in which security price manipulation can lead to the inefficient allocation of resources. The actions of a manipulator can create excess noise in the market which may discourage some investors from participating. We show how a regulator can use trading halts to mitigate the negative impact of manipulation and induce investors back into the market. However, the benefits derived from using halts are somewhat offset by illiquidity costs imposed by the halts on some market participants. Thus, a regulator who must contend with a manipulator is faced with a trade-off between improving allocative efficiency and limiting costs associated with reduced liquidity. Our model demonstrates this trade-off and outlines possible equilibria.Business, Sauder School ofGraduat