Deterring Double-Play Manipulation in Financial Crisis: Increasing Transaction Cost as a Regulatory Tool

The sub-prime mortgage crisis that originated in the United States has triggered a global credit crunch, threatening the solvency of emerging markets that have relied heavily on foreign debt, and resulting in the devaluation of their currencies. Currency market interventions by the central banks in countries with a currency board system lead to higher short-term interest rates and further declinations in the local stock market. This economic setting invites the double-play manipulation strategy that simultaneously attacks both the local currency and the stock market. History has shown that a central bank’s stock market intervention is costly and that sustaining the intervention over a meaningful period of time is a major challenge. In this paper, we examine the effect of a pan-market increase in transaction cost on double-play manipulators’ trading strategies when government intervention is limited to revenues generated by the transaction levy. We show that this regulatory change not only helps sustain equity market intervention but also reduces the short pressure in both the currency and the equity market