Informed manipulation. (Q1421902)

The authors consider some kind of manipulative strategic trading performed by informed insiders. The possibility of manipulative trading is investigated in a Glosten-Milgrom type of the dynamic bid-ask model. The market for one risky and one riskless asset and with one trader is considered. Actually, there are three types of traders, but only one is chosen by nature for any given play of the game. In every period, competitive uninformed market makers post bid and ask prices equal to the expected value, conditional on the observed history of trade in equilibrium, and then the trader trades. In such a frame, it is shown that when the market faces uncertainty about the existence of an informed trader in the market and when the number of trading periods is sufficiently high, every equilibrium involves manipulation by the informed trader. Manipulation endogenously creates liquidity and raises the informed trader long-time profit. The authors claim that their result is robust to the precise specification of the market microstructure. As an example, a three-period simplified model with the equilibrium involving manipulation is presented.