FIN-03-028 |
NYU Stern School of Business |
October 2003
Jianping Mei and Chunsheng Zhou
ABSTRACT
If investors are not fully rational, what can smart money do? This paper provides an
example in which smart money can strategically take advantage of investors’ behavioral
biases and manipulate the price process to make profit. The paper considers three types of
traders, behavior-driven investors who have two behavioral biases (momentum trading
and dispositional effect), arbitrageurs, and a manipulator who can influence asset prices.
We show that, due to the investors’ behavioral biases and the limit of arbitrage, the
manipulator can profit from a "pump and dump" trading strategy by accumulating the
speculative asset while pushing the asset price up, and then selling the asset at high prices.
Since nobody has private information, manipulation investigated here is completely
trade-based. The paper also endogenously derives several asset pricing anomalies,
including the high volatility of asset prices, momentum and reversal.
JEL: G12, G18
Jianping Mei
Institution: Stern School of Business, New York University, 44 West 4th Seet, New York, NY 10012
Telephone: (212) 998-0354
Fax: (212) 995-4233
Email: jmei@stern.nyu.edu
Homepage:http://www.stern.nyu.edu/~jmei
Chunsheng Zhou
Institution: Guanghua School of Management, Peking University, Beijing 100871, China
Email: zhoucs@gsm.pku.edu.cn
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