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Trade-Based Manipulation and Market Efficiency: A Cross-Market Comparison

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 Trade-Based Manipulation and Market Efficiency:
A Cross-Market Comparison

Michael J. Aitken
Chair of Capital Markets Technologies
University of New South Wales
Australian School of Business
aitken@cmcrc.com

Frederick H.deB. Harris

John B. McKinnon Professor of Economics and Finance
Wake Forest University Schools of Business and
Australian School of Business
University of New South Wales
rick.harris@mba.wfu.edu

Shan Ji
University of New South Wales and
Smarts Group International, Inc.
Shan.Ji@smartsgroup.com

Abstract
We develop a testable hypothesis that trade-based manipulation as proxied by the daily incidence of
ramping alerts raises execution costs for completing larger trades on 34 security markets worldwide
2000-2005. The alternative hypothesis is that ramping alerts represent information arrivals that are
delayed, unmasked as rumors, or proven false. Using observational error components to represent
the presence of a manipulator or the arrival of information in a random effects model, we show that
effective spreads are positively related to the incidence of ramping alerts across 8 of 10 liquidity
deciles. The magnitude is economically significant; cutting ramping manipulation by half reduces
the effective spread 31 to 59 basis points in the middle liquidity deciles worldwide. In addition, we
identify the determinants of ramping manipulation by estimating a simultaneous equations model of
alert incidence, spreads, and the probability of deploying real-time surveillance (RTS) across all
listed securities in 2005. Closing call auctions, direct market access, specific regulations, RTS
procedures and enforcement assure better market integrity enhancing market efficiency.

Keywords: Market manipulation, market integrity, spreads, surveillance

JEL Classification: G28 (Financial Institutions & Services, Government Policy & Regulation)

This Draft: 18 November 2009

Acknowledgements: We wish to thank the Security Industry Research Centre of Asia-Pacific

(SIRCA) and the Capital Markets Cooperative Research Centre (CMCRC) II in Sydney for data and
financial support, respectively. Doug Cumming, Tom Smith, and Kumar Venkataraman provided
invaluable advice. The opinions reported herein are personal and do not reflect the policies,
procedures, or opinions of any of our employers.
 Trade-Based Manipulation and Market Efficiency:
A Cross-Market Comparison

1. Introduction
Not all market volatility is natural, deriving from fundamentals. Instead, some volatility is induced by failing
to assure market integrity or by adopting poor market design. Along with fraudulent disclosure and insider
trading, trade-based manipulation is one of the most significant threats to market integrity. With the CBOE
VIX and other indices of volatility reaching record levels worldwide in 2008-2009, major security exchanges
have begun to declare their commitment to surveillance procedures and market designs that best serve the
twin goals of market integrity and efficiency. For example, NASDAQ’s website states

NASDAQ is among the world’s most regulated stock markets, employing

sophisticated surveillance systems…to protect investors and provide a fair and
competitive trading environment... fostering innovative technologies…[ that]
continue to build the most efficient trading environment…to the benefit of all
market participants and investors.

Although many exchanges have invested in significant surveillance resources to detect trade-based
manipulation and improve market efficiency, little is known about the direct relationship between the two.
Primarily this reflects the extreme difficulty of collecting large samples of detailed data about security
market manipulations. In this paper we employ a random effects model to analyze the possible presence of a
manipulator as well as the possible arrival of information each security day, both of which are observed with
error in the market place. In this error components framework, we then investigate whether a reduction in
trade-based manipulation actually achieves tighter spreads. Our analysis covers all the listed securities on 34
exchanges worldwide over the period 2000-2005.
1.1. Theory of Trade-Based Manipulation: An Overview
Allen and Gale (1992) define trade-based manipulation as a trader attempting to manipulate a stock
price simply by buying and then selling (or vice versa), without releasing any false information or taking any
other publicly observable action designed to alter the security’s value.1 Traditional full-information financial
theory asserts that such speculation stabilizes prices because manipulators like all rational speculators buy
when the prices are low and sell when the prices are high. In contrast, with incomplete and asymmetric
information, Hart and Kreps (1986) show that speculation can destabilize prices and increase volatility
because uninformed traders can not distinguish between the rational speculators and strategic insiders with
private information.
As a result of this pooling equilibrium, profitable manipulation can exist under quite general
conditions of expected utility maximization and rational expectations by manipulators, strategic insiders,

1
Trade-based manipulation is thereby distinguishable from other failures of market integrity like insider trading
(Bhattacharya and Daouk 2002) or the spreading of false rumours (Van Bommel 2008).

1
market makers, and noise traders pursuing a momentum strategy (Allen and Gale 1992, Allen et. al. 2006).
Even without momentum traders, Aggarwal and Wu (2006) show that if information seekers can not
distinguish between a manipulator and an informed trader acting strategically, trade-based manipulation can
be profitable. A strategic insider can make unprofitable initial trades against the direction of his information,
set in motion a price trend among partially informed followers, and then profitably unwind his position
against still less informed market makers and other liquidity providers (Chakraborty and Yilmaz 2004,
2007).
With a manipulator present in these nested information environments, the efficient market no longer
serves as an aggregator of equilibrium price information alone. Instead, security price trends may represent
induced volatility rather than the arrival of new information. When markets begin to trend, liquidity
suppliers who were content to earn the spread in mean-reverting markets choose instead to go flat. This
reduction in liquidity may not change the quotes for trivial size, but it does raise the effective spread.
Moreover, with reduced non-execution risk because of the higher volatility, Foucault’s (1999) theory of
order placement implies that liquidity suppliers will then submit orders less aggressively. Aitken, Almeida,
Harris and McInish (2007) confirm empirically that liquidity suppliers in electronic markets will then layer
orders further from the BBO thereby raising the effective bid-ask spread for completing larger trades.
1.2. Prior Empirical Findings on Manipulation
Given this theoretical link between securities market manipulation, induced volatility, and effective
spreads, what does prior empirical research show about the effect of laws, regulations and surveillance
designed to prevent manipulation? When a securities market is laden with manipulators, investors choose to
invest elsewhere. Cumming and Johan (2008) establish that trading activity increases if exchanges adopt
surveillance procedures and regulations that assure market integrity. A number of other empirical studies of
particular events in particular exchanges confirm that manipulation also increases volatility (e.g., Stoll and
Whaley (1987, 1991), Chamberlain, Chueng and Kuan (1989), and Chiou, et al (2007). However, there has
been no direct test of the relationship between manipulation and spreads across securities and exchanges.
Herein, we estimate a random effects model of the error components relationship between trade-based
manipulation and quoted and effective spreads. A doubling of manipulation alert incidence (AI) is
associated with a 31 to 59 basis point increase in effective spreads across 7 of 10 liquidity deciles, which
represents approximately a 10% increase in the moderate liquidity securities across 34 exchanges worldwide
2000-2005.
We then investigate the determinants of ramping alert incidence with a cross-sectional simultaneous
equations model of AI, spreads, and the probability of adopting real time-time surveillance (RTS). The data
is collected daily across all listed stocks in 2005 and then aggregated to the exchange-specific liquidity decile
as a unit of analysis to mirror market surveillance in practice. Factors that affect market quality (trading

2
regulations, market technology, market design infrastructure, market participants) are measured across
exchanges and then related to alert incidence, spreads, and Prob(RTS).
1.3. Our contribution
Using random effects modeling, we show that less ramping manipulation reduces effective spreads by
approximately 10% across the middle liquidity deciles where manipulation is predicted to be most prevalent.
Moreover, we find that a particular design choice (call auctions at the close), a particular technology (direct
market access lines), and a regulation specifically prohibiting ramping manipulation reduce manipulation
alert incidence. Market integrity regulations more generally reduce effective spreads. And real-time
surveillance of trade-based manipulation is more likely to be adopted the lower the volatility, the larger the
trading volume, the higher the foreign direct investment, the faster the execution speeds, the fewer the
competing regulatory objectives, and the greater the risk of market manipulation as proxied by ramping alert
incidence.
The paper proceeds as follows: the next section documents the myriad forms and evidence of trade-
based manipulation. Section 2 explains the random effects methodology, develops our testable hypothesis,
distinguishes a competing alternative, and specifies the empirical models we estimate. Section 3 describes
the data, our measurement of ramping alert incidence, and the distributional properties of AI and spreads
worldwide, concluding with several data-driven limitations of our research design. Section 4 presents and
discusses the empirical results of the error components model. Section 5 addresses the drivers of trade-based
manipulation including an analysis of the dimensions of market quality. Section 6 develops a cross-
sectional empirical model of alert incidence, spreads, and the probability of deployment of real-time
surveillance systems for all listed securities on 24 exchanges in 2005. Section 7 presents a systems
estimation of the simultaneous structural equations for AI, QSpr, and Prob(RTS). A summary and
conclusion are provided.
1.3.1. The Myriad Forms of Market Manipulation
Security market manipulation exists in a wide variety of forms – ramping, wash trades, layering the order
book, churning, cornering, squeezing, front running, bait and switch and other intentionally misleading
orders and trades.2 No matter the form, successful market manipulation temporarily distorts a security’s
price. The overall aim is to drive the price in the direction beneficial to the manipulator who then liquidates
his holdings or covers his short position at a price better than the implicit efficient price in a full-information
equilibrium.
1.3.2. Ramping Manipulation Marking the Close
Ramping manipulation is the focus of the present research because this is the only form of manipulation for
which the requisite data are publicly available. Statistically rare price movements (e.g., less than α = .005)
that revert the following day may indicate market manipulation to artificially inflate or deflate the price of a

2
An Appendix describing each of these in more detail is available from the authors.

3
security. A Ramping manipulation normally involves two surveillance alerts: Marking the Close and then
Reversal at the Start of the next Trading Day. Marking the Close refers to the practice of executing purchase
or sale orders at or near the close of the trading session in order to raise or lower the closing price, the bid or
the offer artificially. In one context Ramping is also referred to as Painting the Tape when a fund manager
manipulates a security’s closing price at the end of the evaluation period. The manipulator’s purpose is to
reduce margin or net capital requirements for enhancing profit and loss, or to influence the mark-to-market
calculations mandated by regulatory authorities for credit authorization or reporting purposes if holding a
large position in derivative contracts.
Figure 1, Panel A illustrates a Marking the Close alert incident screen developed by Smarts Group
International for assisting regulators and brokers in detecting trade-based manipulation. Trades at the ask are
shown in red, and trades at the bid are shown in green. The size of the trade is indicated by the diameter of
the circle. Blue circles represent off-market trades that can be negotiated at prices away from the continuous
auction price beyond a minimum size. Trading volume is shown in the bar diagrams colored yellow. This
particular 21% appreciation observed in the last 15 minutes of trading occurs in less than ½ of 1% of the
trading days for this stock.
Such a significant price increase at the end of the day normally reflects anticipated positive
information arrivals. If, however, these price trends are reversed the next morning, a ramping incident alert
is triggered, as illustrated in Figure 1, panel B. This paper will use such Ramping Alerts (which consists of a
Marking the Close Alert and a Reversal the Next Morning Alert) as a proxy for securities market
manipulation. Of course, such price reversals may also be explained by information announcements that are
quickly reversed, unmasked as rumors, or proven false. Our empirical testing with random effects/error
components modeling is designed to distinguish between these two competing hypotheses.
An Australian Securities Exchange (ASX) case involving the tracking stock on the Standard &
Poor’s ASX 200 Index illustrates the behavior underlying Ramping Alerts. On Friday, 29 June 2001
between 4 and 4:15 p.m., this stock increased 45.5 points or approximately 30% following the closing
auction. The last trading day of the financial year almost always pushes share prices somewhat higher on the
ASX, but on 29 June 2001 the All Ordinaries Index rose by only 2%, and the ASX became concerned that
market manipulation may have been involved in the tracking stock. By market open on the following
Monday, this unusual increase was reversed. Specifically, on 2 July, the index tracking stock fell by 54
points, as the ramping buyers (believed to be fund managers and derivative players) dumped the index
tracking stock and withdrew. Figure 1 Panel B presents a surveillance screen that displayed the Marking the
Close and Reversal the Next Morning alerts for those two days.
1.3.3. Other evidence of closing price manipulations
Flexison and Pelli (1998) and Hillion and Souminen (2004) find that brokers manipulate the closing
price of a stock preceding large agency trades in order to improve their customers’ impression of execution

4
quality. Carhart, Kaniel, Kusto and Reed (2002), and Bernhardt and Davies (2005) show that mutual funds
paint the tape by manipulating closing prices at the end of evaluation periods to improve fund performance
against a closing VWAP benchmark.
Stoll and Whaley (1987), and Chamberlain, Chueng and Kuan (1989) find empirical evidence in the
North American markets that on the expiration day of index futures/option contracts, the price mean-
reversals are significantly higher than month-ends or quarter-ends without index futures/options expiration.
Stoll and Whaley (1991) suggests that the change of settlement procedure to use next day’s opening price in
the New York Futures Exchange and New York Stock Exchange would shift expiration day timing but not
affect the motivation to manipulate closing prices.

2. Hypothesis Development
For the purpose of this research, we focus not on the relationship between manipulation and information-
al efficiency but rather on manipulation and execution costs. Across the 34 exchanges we study worldwide,
we can measure two widely used and accepted relative spreads:
(1) the cost of a round trip transaction at the best bid and offer relative to the quote midpoint (the quoted
spread), and
(2) the average cost beyond the quote midpoint to complete all trades relative to the quote midpoint (the
effective spread).
By maintained hypothesis, market manipulation increases price volatility. Foucault (1999) develops a
theory of order placement relating volatility to effective spreads. Order placement strategy consists of two
components, order type and order aggressiveness. Traders choose from market orders and limit orders.
When non-execution risk is high, traders employ market orders to gain immediate execution. When picking-
off risk is high, limit orders are preferable. Order aggressiveness refers to how close the limit order price is
to the prevailing best bid or offer (BBO) when the order is entered or amended.
Foucault’s theory predicts that when the volatility increases, traders will tend to place limit orders
rather than market orders to reduce their picking-off risk at the cost of higher non-execution risk. When non-
execution risk is also particularly high, liquidity demanders are under pressure to trade immediately upon
arrival and are therefore willing to place market orders at less favorable prices. This induces liquidity
suppliers to post less aggressive limit orders (farther away from the BBO) in order to take advantage of the
impatient traders. The implication is that effective bid-ask spreads (volume-weighting the trade prices that
walk up and down the book) will rise as volatility increases. If the volatility of security markets is indeed
higher in the face of market manipulation, this effective spreads measure of market efficiency will be
adversely affected.
Aitken, Almeida, Harris and McInish (2007) provide empirical evidence supporting the implications
of Foucault’s theory. They hypothesize that hedge funds and proprietary trading desks tend to have short-

5
lived information about valuation and/or the state of the market. As a result, these classes of traders face
higher costs of non-execution and lower picking-off risk than insurance companies and mutual funds. They
hypothesize that the order placement strategy of proprietary trading desks and hedge funds will therefore be
more aggressive than insurance companies and mutual funds. Using a large sample of trading desk
instructions, they show that insurance companies and mutual funds do tend to be less aggressive order
placers, ceteris paribus.
Our testable hypothesis is that trade-based manipulation also reduces order aggressiveness.
Specifically, the null hypothesis of our research is
: A higher incidence of trade-based manipulation (as proxied by ramping alert incidence
AI) is associated with wider effective spreads, ceteris paribus

where AI is the number of alerts per security day triggered by an algorithm implemented by the world’s
leading surveillance technology and consulting firm, Smarts Group International.3
If mean reversion of prices the next morning following an extraordinary price increase (or decrease)
marking the close represents trade-based manipulation, then volatility will have increased, ceteris paribus.
Foucault’s theory predicts liquidity suppliers will therefore reduce their order aggressiveness. Quoted
spreads for trivial depth on electronic markets may remain unchanged as technical transaction costs are
unchanged. Nevertheless, limit orders for larger volume would be spread farther away from the BBO to
avoid being triggered by a manipulator’s walking up/down the order book and then quickly
liquidating/covering his position before the liquidity traders could react. This rational response of liquidity
suppliers to the anticipated presence of a possible manipulator, ceteris paribus, would show up as a higher
volume-weighted effective spread. If a security or exchange exhibits repeated manipulations, we would
expect higher effective spreads to persist, a disreputation effect of failing to assure market integrity.
2.1. Alternative hypothesis
The alternative hypothesis is that ramping alerts represent not market manipulations but rather
information arrivals that are delayed, unmasked as rumors, or proven false. Such information arrivals all of
which are quickly reversed would not lead to wider effective spreads when averaged over longer periods of
months, quarters or years. Rather, under the alternative hypothesis, spreads would quickly mean revert.
In contrast, confirmed information arrivals (both positive and negative) trigger herding and other
information-based trading that cause markets to trend (rather than mean revert). Markets that trend do
exhibit increased spreads as market makers and liquidity traders go flat and protect themselves against
picking off risk. But not so with information arrivals that are quickly reversed. Consequently, under the
alternative hypothesis, information arrivals that are quickly reversed lead to mean reversion of the spread,

3
At present, the SMARTS Market Integrity Platform is deployed in 40+ national exchanges and regulators and 150+
brokers across 35 countries. See www.smartsgroup.com.

6
and ramping alert incidence (AI) if mistakenly capturing information arrivals that are quickly reversed will
be unrelated to long-term average spreads.
2.2. A random effects/error components methodology for trade-based manipulation research
Both information arrivals and market manipulations are inherently unobservable variables, subject a priori to
observational errors. Moreover, since spreads in round trip transactions, and the spread to complete larger
trades, are substantive costs of engaging in market manipulations, we also expect alert incidence to be
determined by relative spreads. Hence, our prior is that relative spreads and AI are endogenously determined.
For both of these reasons, this research utilizes a Random Effects Model to test the correlation between
Ramping Alert Incidence and bid/ask spreads.
In light of the lognormality of the cross-sectional spread, we hypothesize that the theoretical relation
between relative effective spread and ramping alert incidence is

(1)
and transform for estimation to the regression relation
( 1’ )
where
= the relative spread of market i at time t

= a constant

= the percent change of the relative spread with respect to a percent

change of Ramping Alert incidence (i.e., an elasticity)

= the number of Ramping Alerts per security day in market i in period t

= an observational error on information arrivals at time t

= an observational error on Ramping Alert detection in market i

= a residual error term

When a Hausmann specification test fails to reject Cov( ) = 0 and Cov( ) = 0, the
Ramping Alert incidence AI regressor is orthogonal to observational errors across exchanges and over time.
In this circumstance, we employ Da Silva’s autoregressive model:
(2’)

which assumes a mixed variance-component moving average for the error structure of order k determined by
minimizing the RMSE. The Hausmann’s (1978) m test statistic we employ to distinguish these two cases is
distributed with 1 d.o.f.

7
 On the other hand, when the Hausman specification test rejects ( : Cov( ) = 0 and/or

), then we conclude that autoregressive models would be a misspecification

because Ramping Alert incidence is measured with observational error (i.e., is itself stochastic). In that
event, fixed effect dummy variables are used to control for the systematic effects of observational errors in
measuring the arrival of information over time Dt and the presence of a manipulator across securities Di:
(3’)

It is essential to understand that the Random Effects Model specified above will be used to test the
correlation rather than the causality between relative spread and Ramping Alert incidence across securities
markets over time. The Random Effects Model is based on priors about the error components. That is, we
expect spreads to reflect both – the observational error on information arrivals at time t, as well as –
the observational error on manipualtor detection in market i. If is independent of and (i.e., if
Cov( ) = 0 and Cov( ) = 0), then and are not jointly dependent on random
observational errors in detecting informational arrivals over time or market manipulations across securities.
In that event, the correlation between relative spreads and manipulation alert incidence can be estimated
directly without bias.
However, when the Hausman specification test reveals that Cov( ) 0 and/or
Cov( ) 0, then we proceed to fixed effects modeling to address the endogeneity of SPR and AI
both being dependent on idiosyncratic factors across exchanges and over time. The exchange-specific
dummy variables capture idiosyncratic surveillance, detection, prosecution, or enforcement reasons why
manipulation may be observed only with error. The time-series dummy variables control for idiosyncratic
reasons in each time period why information may arrive but be observed only with error. Despite all these
fixed effects control variables, the null hypothesis remains a positive association between and .
2.2.1. Cov( ) Illustrated:
The following examples illustrate various possible findings for the information arrival observational
errors relevant to testing (i.e., that the covariance between Ramping Alert incidence and information
arrival observational errors over time is zero):
(1) A Ramping Alert is triggered by a Reversal the Next Trading Day Alert following a Marking the
Close Alert. The price reversal detected the next morning could result from an information arrival
plus the associated liquidity appearing thereafter in resilient limit order books. Or alternatively, it
could result from ramp-and-dump trading behaviour on the day following a Marking the Close Alert
triggered by a true closing price manipulation. Because in both cases the Ramping Alert would be
triggered, the null hypothesis of zero systematic relationship (i.e., zero covariance) between
information arrivals and Ramping Alert incidence over time would in this example be accepted;

8
 (2) In opposition to (1), if reinforcing positive (or negative) news is announced overnight when the
Marking the Close Alert is triggered, there will be no price reversal the next morning. As the market
continues to trend in response to fundamentals, this stops the Ramping Alert. In such an event, the
null hypothesis of zero covariance between information arrivals and Ramping Alert incidence over
time would be rejected;
(3) What we have been labelling an information event could also have been a non-event. For example, a
pure white noise announcement by a small listed company could be out of traders’ sight and
therefore doesn’t trigger a Ramping Alert. In such a scenario, the null hypothesis of zero covariance
between information arrivals and Ramping Alert incidence over time would be accepted.
2.2.2. Cov( ) Illustrated:
The following examples illustrate various possible findings for the presence of a manipulator observational

errors relevant to testing (i.e., that the covariance between Ramping Alert incidence and manipulator
detection error across securities or markets is zero).
(1) When closing price manipulation is truly present for a security from a market and a Ramping Alert is
triggered for that security, the null hypothesis of zero covariance between Ramping Alert incidence
and manipulation detection error across securities markets would be accepted;
(2) When closing price manipulation is truly present for a security, but due to insufficient monitoring by
momentum traders or arbitrage traders, no one emulates the manipulators’ trading activities, the
manipulation strategy therefore fails and no Ramping alert is triggered. In such a scenario, the null
hypothesis of zero covariance between Ramping Alert incidence and manipulation detection error
across securities markets would be rejected;
(3) The alert detection surveillance process could also generate pure white noise. For example, an
arbitrary time period before closing (e.g., 15 minutes) is used in all markets to detect closing price
manipulation (AI). But the manipulation could occur 30 to 15 minutes before closing or at other
randomly chosen time distances from closing. In such a case, the null hypothesis of zero covariance
between manipulation detection error and Ramping Alert incidence over time would also be
accepted.

3. Data and Measurement

The data for this research is obtained from the Reuters database maintained by the Securities Industry
Research Centre of Asia-Pacific (SIRCA). This database contains intra-day trade and quote data since 2000
for more than 200 exchanges worldwide. We analyze the entire sample of listed securities in all ten liquidity
deciles from each of 34 securities markets for which we could obtain surveillance procedure information.
Table 1 lists the exchanges studied. Because ramping manipulation alerts are so rare at the individual
security-day level, we aggregated security-day observations to the liquidity-decile-day level. Liquidity

9
deciles are determined by dividing the total number of securities in each market into 10 groups, based on
their monthly trading turnover. The period of analysis for our study extends for six years from January 2000
to December 2005.
3.1. Ramping Alert Algorithm
The Ramping Alert algorithm applied in this study is from the SMARTS’ Real-time Securities Market
Surveillance Platform. The algorithm of the Ramping Alert is described below.
Benchmark Period and Threshold
For date T, a historical price change distribution for the past month (the benchmarking period) is created for
each security. The observations in this distribution are sampled wherever on-market trades occur throughout
the benchmarking period. Fifteen minutes after the market opens, we calculate the percentage change
between the trade price and the true price 15 minutes earlier. True price is defined as
(1) the previous trade price; or
(2) the best bid (offer) price at time t-15 minutes if the previous trade price is below (above) the best
(offer) price at t-15 minutes.
Finally, we take the absolute value of the calculated percentage price change and add it to the historical
distribution.
At the end of the benchmarking period, we check the number of observations from each security’s
historical price change distribution. If there are more than 50 observations, then we set the ramping price
change threshold for that security as the 99.5% histogram distribution cut-off. If there are 50 or less
observations from the distribution, then we determine the ramping price change threshold for that security as
follows: Price $0.001 to 0.10—20%, $0.11 to 0.25—15%, $0.26 to 0.50—12%, $0.51 to 1.00—10%, $1.01
to 5.00—8%, $5.01 to 10.00—5%, and above $10.01—3%.
The purpose of the benchmark process is to identify the top ½ of 1 percent of least frequent price
changes for a security during the benchmark period. Assuming that there are approximately 20 trading days
in a month and 100 trades in each trading day (assuming 6 trading hours per day), there are approximately
2000 price change observations each month. If these observations are sorted, the value of the 10th largest
price change is where the threshold for ramping for that security is set. For example, if the 10th highest price
change for BHP Billiton is 0.5% during September, then the security is deemed to have been subject to
ramping if the return in the last 15 minutes of 10 October, 20 October, or 31 October was greater than 0.5%.
Conditions for Marking the Close Alert
After market i closes on date t, for each security, we trigger a Marking the Close Alert if the absolute
percentage difference between the closing price and the true price 15 minutes prior is greater than the
ramping price change threshold for that security.
Conditions for Reversal the Next Morning Alert
On date T+1, for each security, we trigger a ramping alert if the following conditions are satisfied:
(1) if there was a Marking the Close Alert triggered for that security on date T; and

10
 (2) if during the first 15 minutes of trading on date T+1, if the Marking the close Alert triggered on date
T is for driving up (down) closing price by X%, at least one trade occurs at price P that is below
(above) the closing price on date T by more X% or more (a.k.a., Reversal the Next Morning).
The above algorithms are run daily across the 34 securities exchanges over 6 years (2000-2005) to derive the
alert incidence (AI) of ramping manipulation per security day. The AI of daily ramping manipulation per
security day is calculated as the number of ramping alerts triggered for all securities from a liquidity decile in
market i in year Y normalized by the average number of listed securities.
3.2. Time-weighted quoted spread and volume-weighted effective spread
We employ standard time-weighted calculations for the Quoted Spread for each security:

The time weight was calculated by taking the proportion of trading time that each spread existed during a
trading day.
The Effective Spread for each security was calculated as:

where Di,t = the trade direction (D = 1 for buyer initiated trades with trade price above the midpoint price and
D = -1 for seller initiated trades with trade price below the midpoint price). The volume weight was
calculated by taking the volume of each trade as a proportion of the total daily traded volume for each
security. In both cases, negative average spreads per security day and instances where one side of the spread
was absent were removed from the sample.
3.3. Descriptive statistics
3.3.1. Spreads
The descriptive statistics for the average spreads per security year across the 34 exchanges over the 6
year period (2000-2005) are presented in Table 2. It can be seen that the 204 average Quoted Spreads and
Effective Spreads are demonstrably non-normal. For example, the effective spread (“ES”) has mean
( ) of 6.64% and standard deviation ( ) of 0.1383 with skewness of 5.1899 and
kurtosis of 28.7423. After a natural log transform, we observe the distribution of to be
approximately normal ( = -3.4645 and = 1.2172) with skewness of -0.1480 and kurtosis of 0.9826.
The same is also observed for quoted spread. Figure 2 presents the histogram for the two spread measures
before and after the natural log transform. Using the properties of the lognormal distribution and assuming

exact log-normality for our observations, an estimator of would be =

= 6.56%. This mean estimate differs from of 6.64% because our sample differs slightly from an exact
lognormal distribution.
The Quoted Spread varies enormously across the ten deciles (see Table 3, Panel A) from 0.73% for
the most liquid decile to 20.98% for the least liquid decile. Effective Spread varies from 2.19% to 13.56%.
In general, the three thinnest-trading deciles exhibit spreads that are an order of magnitude wider than the

11
three most liquid deciles. These descriptive statistics suggest Deciles 4, 5, 6 and 7 should be grouped as a
separate class of transactions, separate from the thickest and thinnest-trading deciles, and we perform Chow
tests on the estimated models to confirm whether or not to do so. The pooling of the data is rejected.
Consequently, we report below and discuss the regressions for thickly-traded (1,2,3), moderately liquid
(4,5,6,7), and thinly-traded (8,9,10) subsets of the ten liquidity deciles.
3.3.2. Ramping Alert Incidence (AI)
Table 1 shows the mean annual alert incidence of daily manipulation in each of the 34 exchanges.
The grand mean of means is 0.21, meaning 1 in approximately 500 trading days or one every five days per
100 securities. Mean AI ranges from 0.02, 0.03, 0.03, 0.06 and 0.07 in Korea, Istanbul, Shanghai, Shenzhen,
and Hong Kong to 0.45 and 0.44 in the Taiwan and Bombay stock exchanges. The alert incidence in
Singapore and the Euronext markets (0.30 to 0.37) are quite high in the distribution. NASDAQ has a 0.08
AI. Table 3, Panel B presents the mean annual alert incidence of ramping manipulation by security day
aggregated to the decile level across all 34 exchanges. It can be seen that across all securities from 34
markets, the alerts incidence is monotonically decreasing from 0.31 in decile 1 to 0.13 in decile 10. In the
least liquid securities, detection of manipulation strategies by surveillance authorities is too likely. On the
other hand, in the most liquid securities, the capital required to ramp a security is too extensive. Therefore,
we would expect manipulations to be highest in the moderate liquidity deciles 4, 5, 6, and 7.
3.4. Limitations of the error components research design
The higher alert incidence at the top of Table 3, Panel B could be caused by alert detection errors
especially in thickly-traded deciles 1, 2 and 3. In fact, much surveillance workflow is designed to validate
alerts that can be triggered by a variety of legitimate reasons not involving manipulation. It is quite common
that a large proportion of the alerts triggered each day prove to be false positives. And it has become
common surveillance practice to adjust various attributes (e.g., alerting conditions, thresholds, etc.) to have
alerts issued more or less often based on the client exchanges’ capabilities in screening for false positives.
So the problem of false positives in ramping alerts is well known and is likely to be highly correlated
with trading volume. By definition, the surveillance alert count data adjusts for the larger number of
securities in higher liquidity-deciles but not for the fact that these securities are traded more frequently than
those from lower liquidity-deciles. Given the design of surveillance alerts, the higher incidence of false
positives in more liquid securities probably explains the rising monotonic mean AI statistics from decile 10
to decile 1.
We should like to point out however that this false positives data collection issue on AI in fact our
findings against (not in favor of) our testable hypothesis of a positive spread-AI relationship. When mean
reversion occurs as an equilibrating response to random information shocks in resilient limit order books,
liquidity providers tend to tighten the spreads. Decreased picking-off risk in mean-reverting (flat as opposed
to trending) markets results in lower spreads, the opposite of our hypothesized positive relationship between

12
SPR and AI. Hence false positives in our AI data collection would increase the chances of falsifying our
hypothesis, not the reverse.
A second limitation of the error components model structure is that we make no attempt to estimate
the structural equations. Spreads and AI are simultaneously determined or at least determined by common
shocks as seemingly unrelated regressions. Higher AI raises volatility, and volatility reduces order
aggressiveness raising spreads. Spreads are an execution cost of market manipulation; higher quoted spreads
reduce the incidence of manipulation, ceteris paribus. Controling for exogenous volatility in the structural
equation for spreads, our manipulation hypothesis would be that higher AI results in still less order
aggressiveness as induced volatility reduces non-execution risk, again raising spreads.
So, either greater exogenous volatility or greater volatility attributable to manipulation raises
spreads. Here, we are content to trace the simple correlation between spreads and surveillance alerts. Note
that the two can not be spuriously correlated through exogenous volatility, since the spreads-exogenous
volatility relationship is a priori positive, while the basic AI-exogenous volatility relationship is a priori
negative. Specifically, increased exogenous volatility substantially raises the transaction costs of ramping a
market, thereby reducing equilibrium AI. Structural equation estimation is required to sort out these SPR-
volatility and AI-volatility relationships, and we undertake that research in sections 5 and 6 below.

4. Empirical Results of Error Components Model

Table 4 Panel A shows that across all liquidity deciles, effective spreads averaging 664 basis points across
our 34 exchanges are increased by 11.92% (i.e., e0.1126 – 1) or about 79 basis points when ramping alert
incidence doubles. These elasticity parameter estimates from the Full Random Effects Model are unbiased
by covariance between AI and the observational errors (since the Hausman specification test is insignificant)
but they explain only about 5% of the variation in spreads. With full fixed effects introduced for n-1
exchanges and years, the model can explain 81.7% of the variation in spreads with F=18.52, and the SPR-AI
relationship remains positive and significant at 0.01. Again a doubling of ramping alerts is estimated to
increase spreads by 11.14% or 74 basis points. Allowing for a moving average of error components, the AI
parameter estimate declines to a 7.44% increase in spreads or about 49 basis points when AI doubles.
Table 4 Panel B shows that even the relationship between quoted spreads for doing trivial size at the
BBO and AI is positive, though weaker. A doubling of alert incidence raises quoted spreads averaging 699
basis points across our 34 exchanges by 4.00% or 28 basis points. Here, the Hausman test indicates the Full
Random Effects estimate of the SPR-AI relationship is biased by joint interdependence on fixed effects
across exchanges and over time. Controling for exchange-specific dummy variables (31 of 33 of which are
significant) and controlling for annual dummy variables (4 of 4 of which are significant), the model explains
94.3% of the variation in spreads with F=71.3, significant at 0.01, and the AI elasticity parameter (i.e., e0.0392
– 1) remains positive and significant.

13
 Chow tests indicate however that these pooled estimations across all ten liquidity deciles cannot be
validly pooled ( F = 10.09 with p-value less than 0.01) -- i.e., that the All Deciles results are masking
enormous heterogeneity in the SPR-AI relationship across thickly versus thinly-traded stocks. In
disaggregated results available from the authors, Quoted SPR-AI elasticities of less than ½ of 1% are
observed in thickly-traded deciles 1, 2 and no effect in decile 3. Similarly, deciles 4 and 5 shows no effect.
In the moderately liquid deciles 6 and 7, doubling ramping alerts raises quoted spreads by 3.2% or 18 basis
points and by 2.0% or 15 basis points, respectively. Similarly, in decile 8, the estimated SPR-AI elasticity
parameter is a minuscule 1% or 11 basis points. Indeed, it is only in the most thinly-traded stocks that we
observe any economically significant effect of surveillance alerts on quoted spreads. A doubling of ramping
alerts in decile 10 securities raises quoted spreads by 3.2% or 67 basis points. The BBO measure of market
efficiency seems to be affected by failures to assure market integrity only in the thinnest stocks.
Quite the opposite is true of effective spread-AI relationships however. Again, in disaggregated
results available from the authors, in 8 of 10 liquidity deciles the effect of doubling ramping alert incidence
is associated with 31 to 59 basis point of increased effective spread. Among the thickly-traded deciles,
decile 2 exhibits a significant SPR-AI parameter. Doubling alerts increases effective spreads by 4.6% or 11
basis points in the Random Effects Model (and by 3.7% in the Full Fixed Effects Model). In almost all the
moderately liquid and thin-trading deciles, the estimated elasticities of effective spreads with respect to alert
incidence are very substantial: 3.9% x 790 b.p. of mean spread in decile 4 = 31 b.p.,4 7.5% x 523 b.p. of
mean spread in decile 6 = 39 b.p., 8.2% x 721 b.p. in decile 7 = 59 b.p., 5.1% x 770 in decile 8 = 40 b.p.,
5.4% x 1091 b.p. in decile 9 = 59 b.p., and 3.4% x 1356 in decile 10 = 46 b.p. Across 8 of 10 liquidity
deciles, assuring that ramping manipulation is halved provides a very substantial gain of market efficiency in
completing larger trades.
4.1. Discussion of Results
What liquidity demanders must pay to get substantial size done (i.e., the effective spread), in the face
of a doubled incidence of ramping alerts increases substantially even though the quotes for trivial size are
largely unchanged. We find in examining the surveillance data across all listed securities on 34 exchanges
2000-2005 that the market efficiency-integrity relationship is much more sensitive when we account for
actual trading prices rather than the quoted spreads on offer for doing trivial size. In 8 of 10 deciles, doubling
alert incidence increases effective spreads from 3.7% to 8.2% whereas in price quotes, only one decile (i.e.,
decile 10) shows an effect on quoted spreads of this magnitude. So, it is institutional clients seeking larger
trades and the pseudo market makers who provide liquidity to them who would be expected to pressure
exchanges to detect potential manipulators and exclude them from the marketplace.

4
Decile 5 exhibits a 2.7% estimated increased in effective spread on a mean spread of 542 = a 15 basis point increase
from doubling AI.

14
 To understand further the roles of various market participants potentially caught up in a
manipulator’s ramping transactions, we describe below the traders involved in capturing intraday profit.
Closing price manipulations must be distinguished from legging patterns that arise in the normal functioning
of quote-driven or order-driven markets. “Legging” refers to one side of the book changing while the other
side does not (usually as large orders “walk the book”). In mean-reverting, stationary price sequences, most
traders desire to get flat when a legging pattern develops. In non-stationary price sequences, however, trading
profits are available in legging patterns by shorting one side of the market and inventorying the other. For
that reason, intraday traders with sufficient access to order flow data to detect when a market begins to trend,
often desire to participate in the trend. Manipulators know this and attempt to mimic the other natural
players involved in legging patterns.
Legging patterns arise from the buy-side trading of momentum traders, basket traders, and value-
traders operating with no discretion as to timing. And on the sell side, legging patterns arise from the trading
activities of specialists, arbitrageurs, day traders, and fair-weather market makers. We now briefly describe
the behavior of each in turn.
On the buy side, momentum traders typically are impatient, especially if they are buying/selling into
a rising/falling market. Such traders have a significant likelihood of walking the book with market orders of
substantial size, thereby triggering a legging pattern. Basket traders rebalance institutional portfolios, submit
arbitrage trades, and implement portfolio insurance. Baskets may trade as limit, marketable limit or market
orders and hence will periodically walk the book, again triggering legging patterns. Also on the buy side,
value traders may or may not be given discretion by their portfolio managers regarding their execution
strategy. On the one hand, if the portfolio manager requires the value trader to acquire a particular stock
quickly, the result is likely to be a significant price impact resulting from walking the book. Value traders
who have discretion tend to be patient traders, willing to supply liquidity to earn the spread, or issuing
marketable limit orders carefully so as to minimize price impact. However, some value traders with
discretion will use the Value Weighted Average Price (VWAP) trading strategy to attempt to attain or better
the day’s VWAP for traded stocks. When “mousetrapped” some distance from the VWAP at the end of the
day, such trading may be difficult to distinguish from a manipulator’s ramping the close.
On the sell side, specialists and designated liquidity providers have an affirmative obligation to
refresh the book by selling into rising markets and buying into declining markets. If the ask side of the limit
order book is being repeatedly hit, perhaps signaling movement toward a higher equilibrium price, these
traders will temporarily ignore the bid side of the book--a dynamic adjustment pattern that is consistent with
legging as well as ramping. Also on the sell side, those placing limit orders with no affirmative obligation
are likely to fall into three categories: patient traders with money funds, arbitrageurs/day traders, and fair-
weather market makers.

15
 Patient traders with money funds are attempting to minimize trading costs and therefore are not
likely to create substantial price impact. Arbitrageurs and day traders may employ algorithms that monitor
the market in real time examining various metrics to provide very short term estimates of the state of the
market. Limit orders can be profitable in mean-reverting markets, but are picked off (if not cancelled) or left
in the dust in trending markets. Thus arbitragers and day traders will cancel limit orders if their algorithm
indicates a shift from a mean-reverting to a trending state. Such traders, depending upon the strength of their
signal and their aggressiveness, may grab available liquidity in the direction of the trend and feed it back into
the markets after the market settles into a mean-reverting state with limit orders. Such aggressiveness
exacerbates legging patterns and may be mistaken for closing price manipulations.
Fair-weather pseudo market makers will post buy and sell limit orders in mean reverting markets
wherein supplying liquidity is profitable. Their trading algorithms will scan news feeds in real time and if
significantly good/bad news is indicated the algorithm will cancel all limits, grab available limit orders and
perhaps submit market orders to profit on the anticipated move in appropriate investment instruments. As
markets again become mean reverting, the acquired instruments are fed back into the market with limits, and
fair weather market-making resumed. Such pseudo market makers are highly dependent upon rapid
execution and their aggressive behavior can exacerbate and make more feasible ramping manipulations.
4.1.2. Parameter magnitudes
As to the magnitudes, a doubling of mean ramping alert incidence in decile 4 of 0.23 to 0.46 security
days, increases the 790 basis points of mean effective spread across all listed securities in our 34 exchanges
by approximately 3.9%. That means twice the average daily ramping incidence would be associated with 31
basis points of additional execution costs.
In decile 1 (and also decile 3), no significant correlation is found with alert incidence which is
consistent with the expectation that manipulations are more costly and difficult to implement in highly liquid
securities. The elasticity of spreads with respect to alert incidence in the moderately-liquid deciles is much
larger, as expected. Decile 6, for example, exhibits an elasticity of effective spread with respect to AI of
7.47, and decile 7 of 8.18%. The basis point impact on effective spreads is 39 b.p and 59 b.p., respectively,
as AI doubles.
In decile 10, a doubling of ramping alert incidence from its mean of 0.12 to 0.24, increases a much
larger effective spread of 1356 basis points by only 3.4 percent in the Full Fixed Effects Model or 46 basis
points. Other illiquid deciles exhibit similar results as well. For example, in decile 9, 5.4% elasticity in the
Da Silva Autoregressive Moving Average Model raises the effective spread of 1091 by 59 basis points. In
decile 8, 5.13% elasticity in the Da Silva MA model raises effective spreads by 40 basis points. The lower
elasticities in deciles 8, 9 and 10 can be explained by the fact that detection of manipulation activities is too
likely in the least liquid deciles, which drives manipulators away.

16
5. Determinants of Trade-Based Manipulation
Although these correlations between AI and effective spreads using observational error components
are compelling, and the magnitudes are economically significant, the determinants of cross-sectional
variation in ramping incidence and the causal relations remain unknown. To identify the potential drivers of
market manipulation, Aitken (2009) hypothesizes a role for each of the following: Regulation, Trading and
Surveillance Technology, Security Market Infrastructure, and Market Participants. We discuss each of these
hypotheses below.

5.1. Dimensions of Market Quality

5.1.1. Regulation
Bhattacharya and Daouk (2002) confirm a negative relationship between the cost of equity capital and the
enforcement of insider trading laws across 108 countries. Cumming and Sofia (2008) investigate the number
of trading regulations with corresponding surveillance technology to monitor alerts and the existence of a
trading regulation specifically against ramping across 25 exchanges. They find that comprehensive rules
prohibiting trade-based manipulation generate higher turnover and larger market cap.
We hypothesize that security exchanges with regulations specifically against ramping (Variable name:
RampReg) are expected to have fewer ramping manipulations. A larger number of trading regulations
(Variable name: Regs) that have corresponding surveillance alerts (e.g., against front running or other
broker-client conflicts of interest) signify an atmosphere of more aggressive surveillance and should lower
technical transaction costs of trading but may deflect surveillance resources away from the effort to stop
ramping manipulation. Hence, we hypothesize a negative relationship between AI and RampReg, but a
positive relationship between AI and Regs.
5.1.2. Trading and Surveillance Technology
The recent revolution in internet-based order filing has provided investors access to a real-time and
centralized order book with an expedited channel for order submission. The latest development on some
exchanges (e.g., the London Stock Exchange, Direct Edge etc) is the effort to launch an Enhanced Liquidity
Provider Program (ELP), which provides subscribed traders an integrated view of both displayed and dark
pool order books. Historically, traders had to seek executions in either the displayed market or a single "dark
pool". ELP now offers a comprehensive solution for traders looking to aggregate liquidity of all types before
implementing particular execution strategies.5
To keep up with more sophisticated trading, real-time surveillance (RTS) technology has also been
gradually replacing traditional T+N market surveillance or transaction log books. For example, SMARTS,
the leading real-time market surveillance platform from Smarts Group International Ltd., has been deployed

5
According to Reuters (2008), Direct Edge's ELP Program broke the 100 million shares traded/per day mark on 15th
July 2008 while the overall trading volume was 1.23 billion shares on that same day.

17
by more than 50 national securities exchanges and regulators around the world. But there has been no prior
research studying the relationship between RTS technology and market quality. We will use the deployment
of SMARTS as a proxy for eexperience with Real Time Surveillance (Variable name: RTS) technology. In
cross-section we expect exchanges more vulnerable to trade-based manipulations to adopt RTS. Over time
RTS should help reduce the incidence of market manipulation.
Another technology advance is Direct Market Access (DMA) defined as electronic facilities which
allow brokers to offer clients direct access to the exchange trading system through the broker’s infrastructure
without manual intervention by the broker. DMA facilitates algorithmic trading and makes market
manipulation more difficult. To be successful, market manipulators must avoid “signature footprints” and
exit faster than counterparty hedge funds or proprietary trading desks who often adopt algorithmic trading
with computer “bots.” Hal Varian refers to such datarati as “firm[s] whose business hinges on making
smart, daring choices…gleaned from algorithmic spelunking and executed with the confidence that comes
from really doing the math.” Such businesses are difficult to mousetrap on the wrong side of VWAP, to
mislead into chasing false trends, or to manipulate at the close. DMA we predict will be inversely related to
ramping alert incidence.
5.1.3. Security Market Infrastructure
The following dimensions of infrastructure are expected to impact market integrity: (1) the presence of a
closing call auction, (2) volatility defined as the standard deviation of daily returns, (3) market liquidity
defined as the market turnover, and (4) the technical transaction costs measured by quoted spreads. Many
securities exchanges have introduced closing call auctions (Variable name: CallAucDum) to improve market
quality but have achieved mixed results (Pagano and Schwartz 2003, Comerton-Forde and Rydges 2006,
etc). In our context, by allowing traders to unwind their intraday positions and go flat overnight if so
desired, closing call auctions should reduce the exposure to manipulation resulting in tighter spreads as AI
declines.
Higher volatility (Variable name: Vol) leads to less aggressive order placement as non-execution risk
declines for any given picking off risk (Foucault 1999). Thus, volatility results in wider spreads, which
would increase the cost of manipulation resulting in a smaller number of alerts. But manipulation carried out
on securities with higher volatilities should have a lower probability of detection and enforcement since in
volatile price environments less ramping alerts are triggered and legal safe harbors widen.
Securities that are highly liquid normally have big market capitalization and are therefore difficult to
manipulate due to the higher total costs involved to entice momentum traders to chase a false trend. Hence,
we expect higher market liquidity (Variable name: Liq) to be associated with a lower number of alerts.
However, a large proportion of alerts triggered each day are false positives. The problem of false positive
ramping alerts is well known in surveillance research to be correlated with liquidity.

18
 Quoted spreads (Variable name: QSpr), as a measure of the percentage cost of a round trip
transaction at the BBO, is directly proportional to the technical transactional costs involved in manipulations.
It is expected that higher quoted spreads will cause lower market manipulation and alert incidence, ceteris
paribus. In contrast, we showed in section 4 above that effective spreads are positively correlated with alert
incidence. The two are not inconsistent. With so little depth at the BBO in electronic markets, quoted and
effective spreads do diverge. Moreover, in theory, we expect this divergence in relationship to AI. When
non-execution risk is high (for any given picking off risk), liquidity traders prefer market orders or limit
order close to the BBO to gain immediate execution. When non-execution risk declines or picking-off risk
rises, limit orders away from the BBO are preferred. Foucault’s (1999) theory predicts that when price
volatility increases (perhaps because of manipulation) and non-execution risk consequently declines (for any
distance from the BBO), liquidity traders will tend to place less aggressive limit orders in order to reduce
picking off risk, which results in wider effective spreads.
5.1.4. Market Participants
Several emerging markets have encouraged foreign capital investment in their equity markets
hoping that overseas hedge funds and proprietary trading desks would boost liquidity and tend to
stabilize the financial market. But research on several financial crises in emerging markets has tied
those foreign investors to excessive volatilities or bubbles. Chiou, et al (2007) has two related
findings. The first is that extremely low transaction costs and fast adjustment of order placement
with cancellations, pinging, etc. create greater chances for the informed to manipulate the market
and take advantage of the uninformed. This reasoning implies quoted spreads would be a negative
determinant of alert incidence. Chiou also finds that informed foreign direct investors have a
greater incentive to manipulate the market because they are beyond the reach of national security
market regulators. Using the United Nation’s data on foreign direct investment (FDI) as a
percentage of GDP, we predict a positive relationship with AI.
5.2. Research Design
To study the cross-sectional determinants of trade-based manipulation we decided to focus not on
heterogeneous enforcement actions in highly divergent regulatory regimes across exchanges but rather on the
comparable data that is publicly-available worldwide, ramping alert incidence data. As a maintained
hypothesis we assume that trade-based manipulation more generally can be well represented by this ramping
alert proxy. Again, regulators and exchange officials investigate nine other forms of securities market
manipulation using proprietary databases (Ji 2009).
The empirical model structure is a simultaneous set of three structural equations describing ramping
alert incidence (AI), the quoted spread (QSpr), and the deployment of real-time surveillance (RTS) systems:
AI = f (QSpr, RTS, Control variables, Fixed effects) (I)

19
 QSpr = g (AI, RTS, Control variables, Fixed effects) ( II )
RTS = h (AI, QSpr, Control variables, Fixed effects) ( III )
The empirical specifications prove to be highly non-linear with lognormal transformations and a probit
equation. Nevertheless, because each of the endogenous variables could in principle affect the others, we
assure the order condition for identification by excluding from each equation two control variables (3
endogenous-1) present elsewhere in the system. In each equation, the excluded variables are control
variables found to be insignificant in preliminary single-equation estimations of the focal equation but highly
significant in other equations. In addition, we test for and thereafter incorporate into the model, exchange-
specific fixed effects to address the idiosyncratic institutional features prevalent throughout the sample of 24
security markets.6
We hypothesize the following regression relation between the level of ramping manipulation or
conversely the level of integrity of an exchange and the measures for Regulation, Technology, Security
Market Infrastructure, and Market Participants discussed above: 7
+ (I’)

where
= Mean number of daily ramping alerts per security in market i,

= Dummy variable for the deployment of a Real Time Surveillance system in market i,

= Mean Standard deviation of daily returns of securities in market i (a potentially

endogenous variable)
= Market turnover per security in market i

= Mean quoted spread measuring the round-trip transaction costs at the

BBO for securities in market i at time t (another potentially endogenous variable)

= Dummy variable for the existence of a Closing Call Auction in market i

= Dummy variable for the existence of Direct Market Access in market i

= Dummy variable for the existence of a Ramping Regulation in market i

= the residual error term (perhaps a negotiated fee for block execution)

6
These 24 are the only members of our 34 exchange sample for which detailed regulatory data are available.
7
The absence from this list of information generation and disclosure (Pagano and Roell 1996, Lang and Lundholm
1996, and Oved 2002) is intentional because trade-based manipulation rather than insider trading or false rumor
dissemination is the focus of our research.

20
 In deciding where (in which securities and markets) and when to execute, ramping manipulators
consider the round-trip technical transaction costs (the quoted bid-ask spread), any requisite fees and
commissions, the trading volume required to elicit a desired price impact, and the frequency and severity of
civil and criminal penalties. A security’s baseline price volatility (i.e., unramped) often determines the
likelihood of detection by surveillance officials as well as the availability of legal “safe harbors” that reduce
the probability of indictment and conviction. Real-time surveillance (RTS) tends to be deployed in
exchanges that perceive a greater vulnerability to manipulation and at least initially therefore often
experience the higher volatility that accompanies more manipulation alerts.
5.2.1 Simultaneity
Given the potential endogeneity of RTS and volatility(VOL), Hausman-Wu specification tests are
conducted to determine whether simultaneity issues significantly bias the estimates from the above OLS
model of alert incidence. We estimate RTS and VOL as well as QSPR as instrumental variables with a two-
stage least squares (2SLS) procedure and then test for parameter equivalence between the IV and OLS
estimates. For example, we predict Volatility by using the following IV regression relation:

where = the number of trading regulations that have corresponding surveillance alerts in market i,
and other variables are as defined previously.
Although Stoll and Whaley (1987, 1991), Chamberlain, Chueng and Kuan (1989), and Chiou, et al
(2007) all find evidence that price volatility is higher during the time period of manipulation within a
security market, we find little evidence that higher AI increases volatility across securities or exchange-
specific liquidity deciles. Specifically, aggregating individual securities into 10 liquidity deciles (by
turnover) for each of 24 exchanges in 2005, volatility and quoted spread are both exogenous in the cross-
sectional AI equation we study (Hausman-Wu χ2 test 2.09 with fixed effects for 1 d.o.f. yields α = 0.143). In
contrast, in a time-series cross-sectional model structure, volatility would be endogenous a priori.
Similarly, we predict the decision to deploy real-time surveillance using the following specification:

where = Foreign direct investment as % of Gross Fixed Capital to the country of market i,

21
and other variables are as defined previously. Prob(RTS) proves to be endogenous in the structural equations
model I, II, III, as expected.8 Volatility and the rest of the independent variables are specified in raw data
form as control variables, after confirming their exogeneity.

5.2.2. Other Econometric Issues

We find in the Probit analysis of the decision to deploy real-time surveillance that the determinants
of alert incidence and of quoted spreads influence the decision by an exchange as to whether to adopt RTS.
That is, whether to have an RTS capability in Hong Kong may depend upon the presence of order filling
with Direct Market Access (DMA) or the ability to unwind positions in a closing auction (CloseAucDum).
The desire to assure market integrity by reducing the vulnerability to manipulators would lead to more
adoptions of RTS, ceteris paribus.
And the combination of RTS and DMA or RTS and CloseAucDum would then have a rather
different impact on spreads and manipulation alert incidence than DMA or CloseAucDum taken alone.
Consequently, the parametric effects of market design changes in those exchanges that adopt RTS may differ
from those that do not. In the estimation of the three structural equations, we therefore explored the possible
impact of full interaction terms between the deployment of RTS and all the r.h.s. variables using ML
estimation of a Heckman-style selectivity bias model. The results are qualitatively almost identical to and
beyond the scope of the present study.
Beyond potential simultaneity and selectivity bias, there are several other econometric issues to
resolve: 1) the pooling of trading and surveillance data across all liquidity deciles, 2) the relevance of
exchange-specific fixed effects, and 3) the likely cross-equation correlation of the error terms and the
consequent need for systems estimation of equations I, II, III. We address each of these issues below.
5.3 Regulatory Data
We again employ the Reuters database maintained by the Securities Industry Research Centre of Asia-Pacific
(SIRCA). This database contains intra-day trade and quote data for more than 200 world markets 1999-
2005. The Trading Regulations Database from Cumming and Sofia (2008) covers 25 security exchanges for
the years 2005 to 2008. Consequently, our analysis of the determinants of trade-based manipulation
addresses the single year 2005 across all ten liquidity deciles on the overlapping 24 exchanges. Table 1 lists
the securities exchanges studied—14 in the Asia-Pacific region, 6 in Europe, 2 in the U.S., and 2 in Africa.
The analysis is conducted on the entire universe of trades and quotes for all listed securities. We
aggregate the data to obtain a unit of analysis that is an exchange-specific liquidity decile based on their
monthly trading turnover. We term this unit of analysis an “exchange decile” for short.9

8
The pooled OLS and IV (2SLS) estimations across all 10 deciles and 24 markets that underlie these Hausman-Wu
tests are available from the authors. The disaggregated results for thickly-traded deciles 1,2,3 and moderately-liquid
deciles 4, 5, 6 and 7, and for thinly-traded deciles 8, 9, and 10 are reported below in Tables 9, 10, and 11.

22
5.3.1. Descriptive Statistics on Determinants of AI
The descriptive statistics for the following variables are presented in Table 7 below.
• Annual Alert incidence of daily ramping manipulation per security per decile across the 24 securities
exchanges in year 2005 (AI);
• Annual Average Quoted Spread per security per decile across the 24 securities exchanges in year
2005 (SPR);
• Annual Average Standard Deviation of Logarithmic Daily Return per security per decile across the
24 securities exchanges in year 2005 (Vol);
• Annual Average Turnover per decile across the 24 securities exchanges in year 2005 (Liquidity);
• Number of Trading Regulations that are surveillance monitored across the 24 securities
exchanges in year 2005 (Regs).
It can be seen that except for the number of trading regulations that are surveillance monitored (Regs), all the
other 4 variables are demonstrably non-normal. For example, the quoted spread has a mean of 5.36% and a
standard deviation of 0.0956 with skewness of 3.4166 and kurtosis of 13.1504. After a natural log transform,
we observe the distribution of to be approximately normal ( XXX = -3.9911 and

= 1.4776) with skewness of 0.2425 and kurtosis of -0.6729. The same is also observed for AI, Vol and

Liquidity.
Using the properties of the lognormal distribution and assuming exact log-normality for our

observations, an estimator of would be . The Reuters data yields such an estimate of

= 5.51%. This figure closely approximates but differs from the observed mean of

5.36% because our sample differs slightly from a pure lognormal distribution. A quoted spread of 536 basis
points at the mean conveys that this sample of 24 securities exchanges is very different from the lowest
execution costs worldwide where the DJIA stocks trade in New York for 11 basis points. However, the more
appropriate comparison is to the universe of all ten liquidity deciles where Aitken, Cook, Harris, and
McInish (2009) report 61 b.p. for NYSE, 257 b.p. for ASX, 283 b.p. for TSE, 303 b.p. for NASDAQ, 371 for
Euronext, and 381 for Xetra in matched samples.
5.3.2. Final Empirical Specification
In the error components model of sections 2, 3 and 4, we found that exchange-specific fixed effects
contribute significant explanatory power to the relationship between relative spreads and ramping alert

9
To check for any aggregation bias, we introduced fixed effects for the liquidity deciles, omitting decile seven. Not
surprisingly, because a continuous measure of liquidity itself is a right-hand-side variable in all of our models, the
results were qualitatively identical.

23
incidence in many deciles. Therefore, we also investigated the effects of these idiosyncratic institutional
factors here in the structural equations. Three parameters in the AI equation change sign and significance
when the fixed effects are included (Spr, DMA, and RTS), and the R-squared rose from 0.062 to 0.443. All
the parameters in the spreads equation (except Regs) were stable, but R-squared again rose from 0.416 to
0.499 and from 0.597 to 0.906 in the RTS equation.
Based on those findings and the four variables that are near log-normally distributed, we transform
equation I for estimation to the regression relation:10

+ (I’)

where = a dummy variable for each of 23 securities exchanges listed in Table 1; the Egyptian

Stock Exchange (CAI) is omitted as the modal observation. We retain in each final specification all
exchange dummy variables found to be significant at α ≤ 0.05.
In estimating I’, the pooling of thickly-traded stocks in liquidity deciles 1,2, and 3, the moderately-
liquid stocks in deciles 4-7, and the thinly-traded stocks in deciles 8,9, and 10 is rejected by a Wald test (F
yielding α < 0.01). Estimation of the quoted spread and real-time surveillance equations II’ and III’)

yields the same result. Possible heteroskedastic error variances across the liquidity decile groupings neces-
sitate Wald tests, and these too reject the pooling of the liquidity decile data. Consequently, we perform
separate estimations for these 3 subsets of the ten liquidity deciles throughout our subsequent analysis.

6. A Simultaneous Equations Model

6.1 Endogeneity
6.1.1. OLS, 2SLS Results for Moderately-traded Deciles
In the OLS estimation for moderately-liquid securities (shown in Table 8 Panel A), closing call auctions and
direct market access (DMA) reduce alert incidence. These design features may well allow counterparties to
unwind their intraday exposures before potential manipulators can execute ramping manipulation strategies.
Closing Call Auctions (Call) also lower quoted spreads while increasing volatility. Real time surveillance

10
As a robustness check, we relax the log linear functional form specification of the AI and Spread models in equation
(1) by employing maximum likelihood estimation.

24
(RTS) is deployed in asymmetric information environments more vulnerable to manipulation and therefore is
associated in the cross section with higher alert incidence and higher spreads. Higher technical transaction
cost measured by the quoted spread are themselves associated with higher volatility, but controlling for this
effect, the deployment of RTS lowers volatility. Similarly, the presence of regulations specifically
prohibiting ramping (RampReg) suggest a perceived vulnerability to manipulators and proves to be
associated in cross section with higher spreads but like RTS also results, ceteris paribus, in lower volatility.
The 2SLS results for the determinants of AI shown in Table 8 Panel B are qualitatively identical to
the OLS estimates in Panel A. The instruments for volatility (Volhat) and Spreads (Sprhat) are introduced
one at a time and tested separately for exogeneity. Hausman-Wu specification tests fail to reject the
parametric equivalence between the OLS and IV (2SLS) estimates (e.g., Hausman-Wu χ2 test 2.92 for 1 d.o.f.
yields α = 0.09). We conclude that simultaneity bias in the thickly-traded deciles is not material for the AI-
Volatility equation pair or for the AI-Spread equation pair. Subsequent system estimation will address,
however, the remaining possibility of cross-equation correlation of the error terms, using seemingly
unrelated regressions and maximum likelihood estimation.
As to the IV equations for volatility and spreads also in Panel B, larger numbers of security market
regulations about market integrity accompanied by compliance monitoring (Regs) result in lower spreads but
increased volatility. For example, surveillance effort devoted to insider trading violations or front running
may deflect attention from the ramping regulations that most directly influence volatility. Greater turnover
(Liq), as expected, also lowers quoted spreads but raises volatility. Five of 23 exchange dummy variables
were statistically significant in the AI equation, 13 in the volatility equation, and 20 of 23 in the spreads
equation. To uncover so many significant determinants despite the presence of all these fixed effects echoes
the validity of the modeling framework being proposed. Overall, the F-stats are 6.86***, 10.09***, and
161.97***, and R-squared rises to 0.71, 0.70, and 0.98 for the AI, Vol, and QSpr models, respectively.
6.1.2. OLS, 2SLS Results for Thickly-traded Deciles
In the OLS results in Table 9 Panel A, several differences emerge between moderately-liquid and thickly-
traded stocks. As hypothesized, the extraordinarily high transaction costs of manipulation in the thickly-
traded securities causes higher quoted spreads to reduce volatility whereas higher spreads increase volatility
in the moderately-liquid deciles. Positive and significant AI-spread relationships in OLS estimation
disappear in 2SLS estimation. Alert incidence declines with DMA infrastructure but is otherwise difficult to
detect and unrelated to the hypothesized determinants. The Hausman-Wu test for the exogeneity of volatility
rejects the equivalence of the OLS and IV estimates (Hausman-Wu χ2 test 11.53 for 1 d.o.f. yields α < 0.01).
Volatility among thickly-traded securities does appear to be a function of alert incidence and its
determinants. Specifically, referring to the IV estimation in column 2, volatility increases with closing call
auctions and declines with spreads, RampReg, and other monitored integrity Regs. In addition, the

25
deployment of real-time surveillance systems decreases return volatility by an even larger magnitude in these
thickly-traded than in the moderately-liquid stocks.
As to the AI-Spread (market integrity–market efficiency) equation pair, we again conclude based on
the Hausman-Wu test that simultaneity bias is minimal (Hausman-Wu χ2 test 0.40 for 1 d.o.f. yields α =
0.53). In the IV estimation for spreads, shown in the final column, quoted spreads decrease with closing call
auctions and integrity regulations that are monitored. In cross section, higher spreads are associated with the
presence of real-time surveillance and a regulation specifically prohibiting ramping. These results are
consistent across both moderately-liquid and thickly-traded stocks. Again, subsequent investigation will
address SURL and ML estimation because of possible cross-equation correlation of the error terms.
Three of 23 exchange dummy variables were statistically significant in the AI equation, 12 in the
volatility equation, and 18 of 23 in the spreads equation. Overall, the F-stats are 6.86***, 10.09***, and
161.97***, and R-squared for the thickly-traded securities increases with fixed effects to 0.71, 0.93, and 0.97
for the AI, Vol, and QSpr models, respectively.
6.1.3. OLS, 2SLS Results for Thinly-traded Deciles
It can be seen from Table 10 that in the thinly-traded securities deciles, higher spreads are associated
with greater volatility in cross-sectional OLS and 2SLS estimates. Call auctions at the close to unwind intra-
day exposures lowers spreads. Direct Market Access in these thinly-traded securities appear to advantage the
manipulators and raise the incidence of alerts, perhaps because with little liquidity available counterparties at
the end of a ramping scenario cannot find buyers even though execution speed is very fast.
Unlike in thickly-traded and moderately-traded deciles, real time surveillance and ramping
regulations lower both alert incidence and volatility in OLS estimates while continuing to be associated with
higher spreads. Volatility, as usual, raise spreads suggesting more asymmetric information. Market quality
assurance in the form of regulations promoting fair and orderly markets lowers the spread. Liquidity (such as
it is) in these thinly-traded stocks is also sufficient to lower the spread despite higher volatility. Again,
Hausman-Wu tests reject the hypothesis that IV estimations for Vol and QSpr are needed; OLS single
equation results are unbiased.
Six of 23 exchange dummy variables were statistically significant in the AI equation, 5 in the
volatility equation, and 20 of 23 in the spreads equation. Overall, the F-stats are 3.48***, 19.90***, and
32.47***, and R-squared for the thickly-traded securities increases with fixed effects to 0.65, 0.92, and 0.95
for the AI, Vol, and QSpr models, respectively.
6.2. Probability of Real-time Surveillance
Surveillance of financial markets has a long history. The reasons why are both obvious and subtle. The
assurance of market integrity typically requires an aggressive surveillance regime in tandem with regulatory
enforcement against those who conduct prohibited practices. In addition, however, as self-regulatory
organizations (SROs), many exchanges have more extensive obligations to monitor trading, detect

26
manipulative behavior, and punish violators than might exist in an industry like insurance that operates under
detailed and continuous regulatory review and approval.
Real-time surveillance has grown more sophisticated in the last decade concurrent with the growth of
electronic (and especially algorithmic electronic) trading. Today, lower latency and an explosion of trade
executions barely imaginable a few years ago, today necessitate real-time mechanisms for capturing and
processing surveillance data. RTS systems have become a more prevalent response to heightened SRO
obligations and are now deployed in 8 of the 24 exchanges we study.
6.2.1. Probit Model Specification

(III’)

where = The probability of the deployment of Real Time

Surveillance System (i.e., SMARTS) in market i

= an instrument for the mean security days with Ramping Alerts in market i

= the average standard deviation of daily returns of market i

= The average market turnover of market i

= The dummy variable for the existence of direct market access of market i

= Foreign direct investment as % of gross fixed capital to the country of market i

= Residual error term

A priori, we expect the deployment of real-time surveillance systems to increase with an instrumental
variable for greater alert incidence (AIhat), greater vulnerability to manipulation by foreign investors (FDI)
especially those using DMA, and with higher turnover (Liq). Increased turnover magnifies the problem of
false positives in surveillance monitoring, and RTS can help distinguish true from false positives. In
addition, we expect RTS to decline when regulatory attention is deflected to client-agent issues, insider
trading, or other integrity regulations (Regs) and when higher return volatility (Vol) makes prosecuting and
convicting manipulators more difficult.
6.2.2. Empirical Results for Prob(RTS)
Table 11 reports our PROBIT analysis of real-time surveillance system deployment. Panel A pools
the results from all liquidity deciles; subsequent panels B, C and D, report the sub-groupings of liquidity

27
deciles. In the All Deciles results in Panel A as well as in the moderately-liquid securities in Panel B, alert
incidence is positively related to the adoption of RTS, indicating a perceived vulnerability to manipulation
that RTS can help mitigate. Secondly, direct market access (DMA) facilitates quick responses by both
manipulators and counterparties, requiring an expanded capability by the market surveillance officials to
monitor the situations as they evolve. More extensive integrity regulations (REG) serve as something of a
substitute for RTS, deflecting attention from and reducing the likelihood of real-time surveillance. Higher
liquidity (LIQ) increases RTS in thickly-traded and moderately liquid stocks, perhaps because higher
turnover accentuates the problem of false positives in scrutinizing potentially manipulative trades. And RTS
assists in separating the true and false positives in a surveillance program. Finally, a higher percentage of
foreign direct investment (FDI) raises the vulnerability of an exchange to ramp-and-dump manipulative
schemes, so RTS increases to combat it. Overall 16 out of 23 exchanges have significant idiosyncratic
effects, and the LR rises from 94.22 to 289.75 when these exchange-specific fixed effects are incorporated
into the specification.
In Panel B (deciles 4, 5, 6 and7), alert incidence is at its peak because costs of trade-based
manipulation are moderate (unlike in highly liquid securities), yet detection is still quite difficult (unlike in
thinly-traded stocks). For these moderately liquid stocks, higher alert incidence, DMA, higher liquidity, and
foreign direct investment increase RTS. In addition, more numerous integrity regulatory burdens separable
from ramping regulations reduce the adoption of RTS. Overall 11 out of 23 exchanges have significant
idiosyncratic effects, and the LR rises from 59.52 to 115.9 when the exchange-specific fixed effects are
incorporated into the specification.
In Panel C for the most liquid deciles, many of the aforementioned results are quite comparable:
DMA, higher liquidity, and foreign direct investment increase RTS, whilst more numerous regulations
unrelated to ramping reduce the adoption of RTS. On the other hand, higher volatility reduces the
deployment of RTS. In these most liquid stocks not only is trade-based manipulation more difficult to detect
whatever the means of surveillance, but in addition, higher volatility offers a safe harbor legal defense to
alleged manipulators. This makes successful prosecution and enforcement actions much more difficult. In
addition, alert incidence itself is negatively-related to RTS suggesting that with the safe harbors attributable
to high volatility and the surveillance false positives attributable to high turnover, these most liquid stocks
are not the intended target for the deployment of sophisticated RTS systems. Rather many exchanges and
regulators are more focused on the moderately-liquid stocks where detection of manipulators remains
difficult without sophisticated RTS technology. Overall 3 out of 23 exchanges have significant idiosyncratic
effects, and the LR rises from 43.91 to 86.92 when the exchange fixed effects are incorporated into the
specification.
Finally, in Panel D for the least liquid stocks, only DMA and FDI consistently increase the
deployment of RTS. Again, a larger number of regulations unrelated to ramping reduce the deployment of

28
RTS. Variation in volatility probably does not matter because manipulation in these thinnest trading stocks
is easy to detect. Liquidity probably does not matter because so little successful manipulation is attempted in
these 8,9,10 decile stocks that false positives seldom arise. Overall 16 out of 23 exchanges have significant
idiosyncratic effects in these thinnest stocks, and the LR rises from 24.73 to 86.92 when the exchange-
specific fixed effects are incorporated into the specification.

7. Systems Estimation of the Structural Equations

Having established that the probability of deployment of RTS is itself related to alert incidence, volatility,
and the determinants of spreads, we estimate a simultaneous system of equations I’’, II’’, and III’’
characterizing integrity (AI), efficiency (QSpr), and the likelihood of RTS (ProbRTS):

lnAIi = f (lnQSpri, ProbRTSi, Controls{Calli, DMAi,, RampReg i, lnVoli}, 23 Fixed effectsi) + ui ( I’’ )
lnQSpri = g (ProbRTSi, Controls{Calli, RampRegi, lnVoli, lnRegsi}, 23 Fixed effectsi) + vi ( II’’)
Prob(RTS)i = h (lnAIi, Controls{DMAi, lnRegsi, lnVoli, lnLiqi, lnFDIi}, 23 Fixed effectsi) + wi ( III’’)

The estimation is cross-sectional for the entire year of daily trading data in 2005, encompassing all the listed
securities across 24 exchanges aggregated into 10 exchange-specific liquidity deciles. As throughout our
previous work, all ten exchange-deciles can not be validly pooled and are instead grouped for estimation into
thickly-traded deciles 1, 2, 3, moderately-liquid deciles 4, 5, 6, 7, and thinly-traded deciles 8, 9, 10.
A priori, as we hypothesized in explaining our research design in section 5.2, each endogenous
variable could affect all the others. Our previously-discussed empirical findings on simultaneity and model
structure indicate two exceptions. Alert incidence does not affect quoted as opposed to effective spreads,
consistent with our study of error components in section 2, although QSpr is a determinant of AI. And
second, quoted spreads do not affect Prob(RTS). The order condition for identification is satisfied by
excluding Regs and FDI from the AI equation, FDI and DMA from the QSpr equation, and RampReg and
Call from the Prob(RTS) equation. In each case, these identifying variables were insignificant at α = 0.05 in
the equation from which they were omitted.
Because of possible cross-equation correlation of the error terms ui, vi, and wi, we first estimated
seemingly unrelated regressions (SURL) and found the results qualitatively identical to the OLS regressions
discussed above, suggesting Cov(ui,vi) = Cov(ui,wi) = Cov(vi,wi) = 0.11 The 2SLS estimates reported in
Table 12 provide therefore a valid model structure for estimating the determinants of AI and the effects of
the dichotomous decision to deploy RTS. However, RTS is a limited dependent variable. The appropriate

11
Hausman-Wu tests also indicate parameter equivalence between OLS and SURL.

29
estimation method for the (AI, QSpr, ProbRTS) system of equations I’’, II’’, III’’ involving a probit equation
is maximum likelihood; we employ the SAS QLim procedure.
7.1. Real-time Surveillance Equation Prob(RTS)
Table 12 Panel A reports on the determinants of the decision to deploy real-time surveillance systems. Some
of the results do not differ by liquidity decile grouping. Higher alert incidence raises Prob(RTS) in all
deciles. The presence of DMA lines as well as higher foreign participation in the security industry (FDI)
increase the likelihood of RTS systems deployment in all deciles. Sophisticated algorithmic execution using
DMA and the foreign investment banks and proprietary trading desks that often trade algorithmically
necessitate the more sophisticated surveillance that RTS systems offer. Higher FDI is widely thought to
increase threats to market integrity from hedge funds and proprietary trading desks offshore.
Higher turnover (Liq) in both the most liquid deciles 1, 2 and 3 and the moderately-liquid deciles
4,5,6,7 also increase Prob(RTS) primarily because of the accentuation of the false positives problem as
trading volume rises. Again, RTS systems can help distinguish true from false positive alerts. In the thick
and thin-trading deciles, more numerous integrity regulations (REGS) serve as a partial substitute for or
deflect attention from ramping surveillance and decrease the likelihood of deploying an RTS system. For
example, client-broker conflicts compete for surveillance monitoring attention and regulatory enforcement.
Also in the thick and thin-trading deciles, increased volatility reduces the likelihood of deploying RTS
systems. Not so in the moderately liquid deciles. Apparently, the legal safe harbor created for ramping
defendants by more volatile prices and returns does not dissuade the regulators and exchanges from
deploying sophisticated RTS-based surveillance systems where the chances of trade-based manipulation are
greatest.
In the moderate liquidity deciles 4, 5, 6, 7, the Probit model exhibits a Likelihood Ratio of 115.9 and
an Aldrich-Nelson statistic of 0.55. In the thick-trading and thin-trading deciles, the Likelihood Ratio
declines to 86.9, but the Probit model still exhibits an Aldrich-Nelson statistic of 0.55. Overall, the All
Deciles estimation exhibits a Log Likelihood of 289.7 with again a 0.55 Aldrich-Nelson statistic, suggesting
the determinants of Prob(RTS) are more comparable across all ten liquidity deciles than are the determinants
of AI and QSpr.
We wish to reemphasize two points of difference however. Two variables in deciles 1, 2, and 3 and
in deciles 8, 9 and 10 reduce the likelihood of RTS system development: Volatility and Regs. First, recall
that more volatility offers legal safe harbors to alleged manipulators seeking to avoid prosecution, so RTS is
less valuable as a tool for assuring market integrity in those cases because of the difficulty of detecting
violators and securing convictions. Second, an emphasis on insider trading or other integrity regulations
unrelated to ramping appears to decrease the willingness to invest in RTS in exchanges characterized by thin
trading and in the exchanges with highly liquid securities.
7.2. Integrity Equation (AI)

30
 In the moderate liquidity deciles 4,5,6,7 in Panel B of Table 12, we find that the presence of a
closing call auction (Call) reduces the incidence of ramping alerts. Trade-based manipulation proves more
difficult when a manipulator’s counterparties can use closing auctions to unwind their intraday exposures.
High speed execution on direct access (DMA) lines also results in fewer ramping alerts and increased market
integrity. Our interpretation is that counterparties are able to employ DMA to set preventative algorithms in
place that render ramp-and-dump manipulation unprofitable. The probability of deployment of RTS is
significantly positively related to alert incidence. In the absence of any multi-year panel data on the dynamic
effects of RTS, what we are observing in cross section is the perceived vulnerability of certain exchanges to
manipulation and their consequent deployment of RTS plus the regulatory regimes required to assure better
market integrity. Two exchanges (Shanghai and Shenzhen) have significant dummy variable effects at α =
0.05 (both negative, suggestive of greater market integrity), and the alert incidence model for moderate
liquidity deciles exhibits an OLS adjusted R-squared of 0.327 with a 99% F test (5.20,11).
For the most liquid deciles 1, 2 and 3, also in Panel B, direct access execution on DMA lines again
results in fewer ramping alerts and increased market integrity. In addition, we find that higher quoted
spreads (which are associated with more asymmetric information in these most liquid securities) increase the
incidence of ramping alerts. Manipulation always necessitates substantial trading volume but especially so
in these highly liquid securities, and the more asymmetric the information, the more likely momentum
traders will become involved in reaching that trading volume required for manipulators to execute a ramp-
and-dump strategy. None of the numerous other determinants from the moderately-liquid subsample are
significant, suggesting that manipulation is often prohibitively costly to execute and true positive
surveillance alerts are less effectively distinguished from false positives in these most liquid stocks. Three
exchanges (Shenzhen, Korea and New Zealand) have significant dummy variable effects at α = 0.05 (all
negative, suggestive of greater market integrity). The alert incidence model exhibits an OLS adjusted R-
square of 0.665 and a 99% F test (16.69, 9). For this moderately-liquid set of securities, the Log Likelihood
statistic for the ML estimation is -209.3.
In the thin liquidity deciles 8,9,10, displayed in the third row of Panel A, we find that the presence of
a regulation specifically prohibiting ramp-and-dump manipulation (RampReg) reduces the incidence of
ramping alerts. Potential manipulators appear convinced that the exchange will pursue violators who are
relatively easily detected in these thinly-traded securities, and consequently fewer ramping alerts are
observed. Two exchanges (Xetra and New Zealand) have significant dummy variable effects at α = 0.05 (the
first negative, indicative of more market integrity in thinly-traded securities, but the second positive,
indicative of lower market integrity).
None of the other determinants from the more liquid deciles are significant, suggesting again that the
“action” in trade-based manipulation is focused not here but on the moderately-liquid stocks where
surveillance-based detection is much more difficult. The alert incidence model for these thinly-traded deciles

31
exhibits an OLS adjusted R-square of 0.401, a 99% F test (6.29, 9), and the Log Likelihood statistic for the
ML estimation is -175.79.
7.3. Efficiency Equation (QSpr)
Although our primary focus remains on alert incidence and real time surveillance, Table 12 also
displays results for the determinants of time-weighted quoted spreads (Panel C). In all deciles, closing call
auctions and more regulations in pursuit of market integrity (Regs) lower quoted spreads. The probability of
deployment of RTS and a regulation specifically prohibiting ramping (RampReg) indicate in cross-section
the perceived likelihood of more ramping which as we have seen in the previous OLS and 2SLS estimations
is associated with higher quoted spreads. Twenty of 23 exchanges have significant fixed effects at α = 0.05
(both negative and positive) in the moderately liquid and thinly-traded deciles. Adjusted R-squares range
from 0.862 to 0.904 with 99% F tests. For the most liquid deciles, again closing call auctions and more
regulations in pursuit of market integrity decreases the quoted spread.

8. Summary and Conclusion

Our research examines trade-based market manipulation at the close and the relationship between
this market integrity concept and the relative spread, a standard measure of market efficiency. Using market
surveillance techniques we calculate ramping alert incidence (AI) across securities on a daily basis. AI is a
proxy for the inherently unobservable presence of a manipulator. The event of information arrival is also
inherently unobservable. Consequently, we first model the error components of AI and SPR across stocks
and over time as observational errors in a random effects model. Later we provide a factor analysis of the
determinants of AI. The unit of analysis is the exchange-specific liquidity decile across 34 securities
markets worldwide in 2000-2005.
We develop a hypothesis that trade-based manipulation as proxied by the incidence of ramping alerts
raises execution costs for completing larger trades. If mean reversion of prices the next morning following a
statistically extraordinary price marking the close represents ramping manipulation, then we would expect
limit order placers to reduce their order aggressiveness. Quoted spreads for trivial depth might remain
unchanged but limit orders for larger volume would be spread farther away from the BBO to avoid being
triggered by a manipulator’s walking the order book and then liquidating/covering his position before other
traders could react. This rational response to the anticipated presence of a possible manipulator would show
up as higher effective spreads in both order-driven and quote-driven markets averaged over long periods. The
alternative hypothesis is that ramping alerts represent information arrivals that are delayed, unmasked as
rumors, or proven false. Such information arrivals that are quickly reversed would not lead to wider effective
spreads when averaged over long periods.
Our findings on the relationship between market integrity and efficiency are two-fold. First, variation
in trade-based manipulation across security exchanges and over time does raise the execution costs of larger

32
trades. We find ramping alert incidence positively related to effective spreads in 8 of 10 deciles from the
most liquid to the thinnest-trading securities. In contrast, as expected, quoted spreads are largely unaffected
by alert incidence, after controlling for full time-series and cross-sectional fixed effects.
Second, the magnitude of the decrease in effective spreads when ramping manipulation incidence
halves is economically significant -- i.e., 31 to 59 basis points worldwide. This compares with an average
effective spread of 27 basis points for all deciles of securities on the NYSE (Aitken, Cook, Harris, McInish
2008), and 219 basis points in the most liquid decile 1 stocks worldwide. As we have shown, ramping
manipulation is most likely in the moderate liquidity deciles 4, 5, 6, and 7 where surveillance detection is
less likely than in illiquid stocks and yet capital requirements for a successful manipulation are somewhat
reduced relative to the most liquid stocks. In these moderate liquidity deciles, effective spreads are much
higher averaging 523 to 790 basis points across the 34 exchanges. Therefore, the effect of doubling or
halving AI is approximately a 10% change in execution costs for completing larger trades. In sum, we find
market integrity does substantially affect market efficiency worldwide.
We conjecture that ramping manipulation has little or no effect on the quoted spread, yet decreases
market efficiency farther up the book because so little depth is posted at the BBO on electronic limit order
books (typically only 50 to 100 shares). Time-weighted quoted spreads only reflect technical transaction
costs like inventory, clearing and settlement costs, not active management of trading interests. Volume-
weighted effective spreads reflect the cost of completing larger trades that are material to trading desk and
portfolio management performance. Layering of order placements up and down the limit order book is a
rational way for active traders to participate in price moves yet capture intraday trading profit (Aitken,
Almeida, Harris, and McInish 2007). As ramping manipulation activity increases, rational layering requires
less aggressive order placement than would be optimal in the absence of ramping manipulation.
As to the determinants of ramping incidence from our simultaneous equations cross-sectional model,
we find direct market access (DMA) reduces ramping manipulation. Our interpretation is that DMA lines
and the algorithmic countertrading strategies they facilitate can circumvent the pump and dump tactics of a
ramping manipulator. Similarly, call auctions at the close provide an escape mechanism for counterparties to
market manipulator trades; ramping manipulation tactics are better executed in pure limit order books.
Consistent with empirical analysis of legal institutions by Cumming and Johan (2008) and Eleswarapu and
Venkataraman (2006), we find regulations specifically prohibiting ramping manipulation also reduce the
incidence of ramping alerts. Finally, the probability of adopting real time surveillance (RTS) systems is
found to be positively related to ramping alert incidence. In the absence of any panel data on the dynamic
effects of adopting RTS, what we are observing in cross section is the perceived vulnerability of certain
exchanges to manipulation and their consequent adoption of RTS plus the regulatory regimes required to
assure better market integrity.

33
 As to the probability of adopting real time surveillance, we find Prob(RTS) across markets rises with
increased ramping alert incidence, increased trading volume, and increased foreign direct investment (FDI),
as expected. Mid-liquidity deciles remain the focus of manipulator activity but across markets, as trading
volume increases, exchanges and exchange regulators are more likely to implement RTS to keep track of the
complexity introduced by layering, slicing and dicing, and order cancellations in thickly-traded securities.
Increased FDI also causes stock exchanges to adopt RTS in order to match the more sophisticated trading
strategies of global private equity and hedge fund investors they encounter. Predictably, the adoption of RTS
is also more likely when DMA lines make the speed of trading difficult for human surveillance analysts to
monitor. Conversely, RTS is less likely to be adopted when volatility rises. Price volatility in especially
noisy markets like Thailand raises the incidence of false positives, so less sensitive monitoring tools than
RTS prove attractive. Finally, RTS is also less likely to be adopted when surveillance and enforcement
activity and resources are dispersed across a larger number of market integrity regulations (e.g., against
insider trading, fraudulent disclosure, broker-client conflicts, etc.)
Our findings have important policy implications for many securities exchanges in terms of market
design and market surveillance. First, the exhibited relationship between alert incidence and effective spreads
indicates trade-based manipulation has a significant impact on execution costs. Therefore, the prevention of
securities market manipulation not only serves the indirect purpose of improving an exchange’s reputation
for market integrity but also contributes directly to achieving a more efficient marketplace. Second, our
results indicate that some market design changes can enhance the regulatory efforts to prevent securities
market manipulations. For example, to prevent manipulators from marking the closing price, some
exchanges could choose to adopt a closing auction or a random closing time, which would make
manipulation more costly. Nevertheless, no securities exchange can be designed perfectly. Consequently,
exchange and broker-level surveillance backed by effective regulatory enforcement is a necessary and
pivotal complement to good design choices.

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Table 1 List of Securities Exchanges Covered and Mean Alert Incidence (All Stocks) 2000-2005

36
 Index Securities Exchange Home Country Alert Incidence
1 American Stock Exchange U.S. 0.19
2 Australian Securities Exchange Australia 0.25
3 Bombay Stock Exchange India 0.44
4 Cairo Stock Exchange Egypt 0.14
5 Colombo Stock Exchange Sri Lanka 0.16
6 Copenhagen Stock Exchange Denmark 0.17
7 Deutsche Bourse-Extra Germany 0.10
8 Euronext Amsterdam Netherlands 0.32
9 Euronext Brussels Belgium 0.35
10 Euronext Paris France 0.30
11 Euronext Portugal Portugal 0.37
12 Hong Kong Stock Exchange China 0.07
13 Istanbul Stock Exchange Turkey 0.03
14 Jakarta Stock Exchange Indonesia 0.21
15 Johannesburg Stock Exchange South Africa 0.07
16 Korea Stock Exchange Korea 0.02
17 Kuala Lumpur Stock Exchange Malaysia 0.40
18 London Stock Exchange U.K. 0.32
19 Madrid Stock Exchange Spain 0.15
20 Milan Stock Exchange Italy 0.23
21 NASDAQ U.S. 0.08
22 National Stock Exchange India 0.37
23 New York Stock Exchange U.S. 0.26
24 New Zealand Stock Exchange New Zealand 0.28
25 Oslo Bors Norway 0.17
26 Shanghai Stock Exchange China 0.03
27 Shenzhen Stock Exchange China 0.06
28 Singapore Stock Exchange Singapore 0.36
29 Stock Exchange of Thailand Thailand 0.13
30 Stockholm Borsen Sweden 0.23
31 Swiss Stock Exchange Switzerland 0.15
32 Taiwan Stock Exchange Taiwan 0.45
33 Tokyo Stock Exchange Japan 0.16
34 Toronto Stock Exchange Canada 0.22
Mean 0.21
Std. Dev. 0.18
Obs. (34 exchanges x 6 years) 204

Table 2 Descriptive Statistics Quoted and Effective Spreads, 34 Markets, 2000-2005

Panel A: Moments for Raw Spreads

37
 Quoted Spread Effective Spread

Mean 6.99% 6.64%

Std. Dev 0.4994 0.1383
Skewness 1.2689 5.1899
Kurtosis 1.7947 28.7423
No. of Observations 204 204

Panel B: Moments for Natural Log of Spreads

Quoted Spread Effective Spread

Mean -3.1555 -3.4645

Std. Dev 1.1513 1.2172

Skewness -0.6831 -0.1480
Kurtosis -0.3900 0.9826
No. of Observations 204 204

38
 Table 3, Panel A Mean Spreads by Deciles

Quoted Spread Effective Spread

Decile 1 (Most Liquid) 0.73% 2.19%

Decile 2 1.28% 2.88%
Decile 3 1.85% 3.26%
Decile 4 2.56% 7.90%
Decile 5 3.72% 5.42%
Decile 6 5.36% 5.23%
Decile 7 7.52% 7.21%
Decile 8 10.89% 7.70%
Decile 9 15.02% 10.91%
Decile 10 (Least Liquid) 20.98% 13.56%

Grand Mean 6.99% 6.64%

Panel B Mean Alert Incidence by Decile

Decile 1 (Most Liquid) 0.31

Decile 2 0.27
Decile 3 0.22
Decile 4 0.23
Decile 5 0.23
Decile 6 0.22
Decile 7 0.19
Decile 8 0.16
Decile 9 0.12
Decile 10 (Least Liquid) 0.13

39
 Table 4 Error Components Model of Efficiency-Integrity Relationship for All Deciles
Panel A Effective Spreads

All Deciles Full Random Effects Mean Spread: 6.64% Intercept: -3.23*** (t= -15.62) AI Parameter: 0.1126*** (t=3.26) Hausman M Test: 0.23 (>0.64)
(N: 204) R-square: 0.0500 F Test: 10.63***
MA Error Components Mean Spread: 6.64% Intercept: -3.31*** (t=-16.47) AI Parameter: 0.0718***(t= 4.00)
( N:204, MA Order=3) R-square: 0.0246 F Test: 5.09***
Full Fixed Effects Mean Spread: 6.64% Intercept: -4.75*** (t=-17.95) AI Parameter: 0.1081*** (t=3.02)
( N:204) Exchange Dum: 30 out of 33 Year Dum: 4 out of 4 (F=3.47***) R-square: 0.8117 F Test: 18.51***

Panel B Quoted Spreads

All Deciles Full Random Effects Mean Spread: 6.99% Intercept: -3.07*** (t= -15.23) AI Parameter: 0.0432** (t=2.32) Hausman M Test: 4.08 (>0.04)
(N: 204) R-square: 0.0260 F Test: 5.39***
MA Error Components Mean Spread: 6.99% Intercept: -3.10*** (t= -15.43) AI Parameter: 0.0264
( N:204, MA Order=4) R-square: 0.0111 F Test: 2.26
Full Fixed Effects Mean Spread: 6.99% Intercept: -4.50*** (t= -32.44) AI Parameter: .0392** (t= 2.09)
( N:204) Exchange Dum: 31 out of 33 Year Dum: 4 out of 4 (F=5.5***) R-square: 0.9426 F Test: 71.30***

40
 Table 5 Descriptive Statistics for 24 Markets in year 2005
Panel A: Moments for Raw Observations
AI SPR Vol Liquidity Regs

Mean 0.1775 5.36% 0.0409 97120486 6.7500

Std. Dev 0.1876 0.0956 0.0446 365031297 3.9053

Skewness 1.7931 3.4166 3.9966 7.3444 0.6062

Kurtosis 3.2889 13.1504 17.1601 63.4832 -0.2879

No. of Observations 240 240 240 240 240

Panel B: Moments for Natural Log of Observations

AI SPR Vol Liquidity Regs

Mean -2.5002 -3.9911 -3.4882 15.1705 1.3483

Std. Dev 0.8547 1.4776 0.7877 3.3841 2.2723

Skewness 0.1977 0.2425 -1.5412 -0.7449 -4.1936

Kurtosis 3.4063 -0.6729 3.3485 0.2987 16.9851

No. of Observations 240 240 240 240 240

41
Table 6 OLS and 2SLS AI Equations and IV equations for potentially endogenous variables Vol
and QSpr for moderately-traded deciles in 2005
Panel A: OLS
With Fixed Effects AI Model Volatility Model Spreads Model
F-test 6.86*** 10.09*** 161.97***
R-square 0.7102 0.7023 0.9830
βspr -0.3522(t= -1.21) 0.1995*** (t=3.55) N/A
βcall -1.3882***(t=2.66) 2.1948***(t=9.23) -3.9521***(t=-17.99)
βDMA -0.8916 (t=-0.76) N/A N/A
βRTS 1.1498***(t=3.18) -2.6347*** (t=-10.07) 10.5837***(t=20.16)
βRampReg 0.6178(t=1.45) -2.7780** (t=-8.16) 22.1870***(t=19.87)
βvol 0.0803(t= 0.82) N/A 0.4125***(t=4.68)
βregs N/A 0.0473**(t=2.13) -1.4952***(t=-17.38)
βliq N/A 0.2327(t=4.74) -0.3485***(t=-15.03)
βexch 5 out of 23 13 out of 23 20 out of 23

α -1.4953( t=-1.55) -2.7532***(t =-12.51) 5.5170***(t=13.43)

Panel B: 2SLS
With Fixed Effects Instrument: Volatility Instrument: Spread
Hausman-Wu Stats 2.92 0.03
AI Model Volatility Model AI Model Spread Model
F-test 5.16*** 4.61*** 5.12*** 16.07***
R-square 0.4037 0.5352 0.4015 0.8446
βspr -0.1594(t=-1.33) 0.4970**(t=2.51) 0.2482( t=1.19) N/A
-1.3477***(t=-
βcall 1.9304***(t=5.36) -1.3473**(t=-2.61) -3.7108***(t=-5.35)
2.67)
βDMA -0.4566(t=-1.20) N/A -0.3400(t=-0.78) N/A
βRTS 1.1392***(t=3.13) -2.3076***(t=-5.90) 0.9515**(t=2.53) 11.8457***(t=7.17)
βRampReg 0.5642*(t=1.75) -2.3800***(t=-4.69) 0.5707*(t=1.69) 26.4773***( t=8.00)

42
βvol 0.0979(t=0.38) N/A 0.1409(t=0.27) 0.9962***(t=4.09)
βregs N/A 0.2137(t=0.67) N/A -1.9181***(t=-7.88)
βliq N/A 0.1671*** (t=3.47) N/A -0.2325***(t=-4.27)
βexch 13 out of 23 8 out of 23 4 out of 23 20 out of 23

α -1.3900( t=-1.32) -3.9844***(t =-8.82) 1.6026(t=-0.71) 2.3468***(t=2.77)

43
Table 7 OLS and 2SLS AI Equations and IV equations for potentially endogenous variables Vol
and QSpr in thickly liquid deciles of 24 Securities Exchanges in 2005
Panel A: OLS
With Fixed Effects AI Model Volatility Model Spread Model
F-test 16.69*** 26.39*** 55.97***
R-square 0.7079 0.9309 0.9682
βspr 0.2550*(t= 1.99) -0.1596*** (t=-2.97) N/A
βcall 0.3995(t=1.06) 1.7444***(t=9.76) -2.3986***(t=-7.87)
βDMA -0.7370** (t=-2.00) N/A N/A
βRTS -0.1391(t=-0.38) -2.0008*** (t=-7.97) 7.8736***(t=9.10)
βRampReg 0.0043(t= 0.01) -1.2003*** (t=-3.50) 18.5677***(t=8.92)
βvol -0.3466(t= -1.39) N/A -0.1900(t=-1.01)
βregs N/A -0.1138***(t=-3.79) -1.4223***(t=-8.51)
βliq N/A 0.0194(t=0.46) -0.3184***(t=-11.25)
βexch 3 out of 23 12 out
Panel B:of2SLS
23 18 out of 23

α
With Fixed -1.7210*** ( t= -2.89) -3.8249***(t =-17.38) 3.2526***(t=4.36)
Instrument: Volatility Instrument: Spread
Effects
Hausman-Wu
11.53*** 0.40
Stats
AI Model Volatility Model AI Model Spread Model
F-test 8.53*** 0.61 15.58*** 29.30***
R-square 0.5531 0.2370 0.6934 0.9374
βspr/sprhat 0.2940(t=1.61) -0.0752(t=-0.11) 0.1488( t=0.68) N/A
βcall 0.9707(t=1.12) 0.7978(t=0.91) 0.4894(t=1.20) -2.4694***(t=-4.80)
βDMA -2.2920(t=-1.15) N/A -0.9907**(t=-2.08) N/A
βRTS 1.9729(t=0.72) 2.5008 (t=0.46) 0.2303(t=0.60) 7.6212***(t=10.50)
βRampReg 0.6088(t=0.68) 2.6388(t=0.78) 0.0541(t=0.14) 17.9909***( t=5.27)

44
βvolhat/vol -1.3295(t=-1.10) N/A -0.5944(t=-1.27) -0.4863(t=-0.22)
βregs N/A -0.3716**(t=-1.96) N/A -1.3883***(t=-3.58)
βliq N/A 0.0934*** (t=2.64) N/A -0.2845(t=-1.49)
βexch 3 out of 23 2 out of 23 3 out of 23 17 out of 23

α -5.3393( t= -1.24) -3.3627(t =-1.34) -3.2541**(t=-1.97) 1.6922(t=0.18)

45
 Table 8 OLS and 2SLS AI Equations and IV equations for potentially endogenous variables Vol
and QSPR in thinly-traded deciles of 24 Securities Exchanges in 2005
Panel A: OLS
With Fixed Effects AI Model Volatility Model Spread Model
F-test 3.48*** 19.90*** 32.47***
R-square 0.6543 0.9154 0.9464
βspr -0.0009(t= -0.02) 0.4132***(t=3.02) N/A
βcall 2.1942(t=1.08) 0.8322(t=1.09) -3.3923***(t=-5.88)
βDMA 3.6283*(t=1.82) N/A N/A
βRTS -6.6846**(t=-2.07) -1.5364(t=-0.80) 9.8075***(t=7.84)
βRampReg -5.7615**(t=-2.09) -2.5914(t=-0.67) 19.9007***(t=8.02)
βvol -0.8529(t= -0.63) N/A 0.3999***(t=5.39)
βregs N/A 0.0434(t=0.16) -1.3158***(t=-7.20)
βliq N/A 0.3760***(t=6.86) -0.3351***(t=-5.71)
βexch 6 out of 23 5 out of 23 20 out of 23

α -5.6848**( t=-2.46) -6.3500***(t =-9.63) 4.7542***(t=5.39)

Panel B: 2SLS
With Fixed
Instrument: Volatility Instrument: Spread
Effects
Hausman-
5.45 0.47
Wu Stats
AI Model Volatility Model AI Model Spread Model
F-test 4.76*** 12.73*** 5.96*** 0.02
R-square 0.4087 0.6488 0.4640 0.0015
βspr -0.5534(t=-1.02) 0.4971**(t=2.49) 0.1943( t=0.62) N/A
βcall 0.2628(t=0.36) 0.4125(t=1.53) 0.7056(t=1.17) -4.2293(t=-0.05)
βDMA 0.7475(t=0.87) N/A -0.0439(t=-0.07) N/A

46
βRTS -1.1742(t=-1.62) -0.7679***(t=-2.99) -1.2001*(t=-1.81) 61.7170(t=0.03)
βRampReg -1.3938*(t=-1.98) -1.1679***(t=-3.28) -1.3280**(t=-2.14) 117.3303( t=0.03)
βvol -0.7525(t=-1.27) N/A -0.0096(t=-0.03) -42.2121***(t=-0.03)
βregs N/A -0.0418(t=-1.19) N/A -11.1745***(t=-0.03)
βliq N/A 0.4442*** (t=8.10) N/A 9.1848(t=0.03)
βexch 2 out of 23 3 out of 23 2 out of 23 0 out of 23

α 7.0739*( t=-1.92) -7.0548***(t =-17.03) -2.0224(t=-0.94) -248.988(t=-0.03)

47
Table 9 PROBIT Analysis of Real-time Surveillance System Deployment

Panel A: All Deciles

Discrete Response Frequency 0 (65%) 1 (35%)
Without Fixed Effects With Fixed Effects
N 240 240
Log Likelihood -97.76 -3.4718E-8
Likelihood Ratio 94.22 289.75
Aldrich-Nelson 0.28 0.55
βai 0. 1327** (t=2.13) 1.3573( t=0.25)
βDMA 1.5636***( t =6.48) 142.39***(t=59.88)
βregs -0.0988***( t= -3.29) -3.2514(t=-0.09)
βvol -0.3184**( t=-1.97) 7.0394 (t=0.70)
βliq 0.0968*** ( t= 2.67) -2.4852(t=-0.08)
βFDI 1.7875*** (t= 3.46) 83.6882***(t=87.90)
α --3.3926*** ( t= -3.36) -37.7427***(t=-15.87)

βexch N/A 16 out of 23

Panel B: Decile 4, 5, 6, 7
Without Fixed Effects With Fixed Effects
N 96 96
Log Likelihood -28.19 -6.4724E-8
Likelihood Ratio 59.52 115.9
Aldrich-Nelson 0.38 0.55
βai 1.1149*** (t=3.19) 1118.7557**( t=2.17)
βDMA 2.8118***( t =3.91) 2315.6456***(t=7.68)
βregs -0.2222***( t=-2.94) -94.0829(t=-0.62)
βvol -0.1999( t=-0.45) 207.2831 (t=0.98)

48
βliq 0.3120** ( t= 2.53) 102.5849(t=0.71)
βFDI 0.6523 (t= 0.77) 704.7527***(t=39.28)
α -4.3470* ( t= -1.65) -378.0217***( t =9.92)

βexch N/A 11 out of 23

Panel C: Decile 1, 2, 3
Without Fixed Effects With Fixed Effects
N 72 72
Log Likelihood -21.50 -3.2837E-8
Likelihood Ratio 43.91 86.92
Aldrich-Nelson 0.38 0.55
βai 0. 4221* (t=1.65) -382.0626***( t=-7.26)
βDMA 1.5285**( t =2.49) 4224.9291***(t=1283.78)
βregs -0.1133*( t=-1.72) -9.5370(t=-0.02)
βvol -2.0903**( t=-2.52) -1143.8055*** (t=-105.47)
βliq 0.4128*** ( t= 2.97) 49.9484(t=0.57)
βFDI 2.5194* (t= 1.69) 3155.9683***(t=1191.19)
α -14.8848*** ( t= -3.20) -10306***(t=-3130.69)

βexch N/A 3 out of 23

49
 Panel D: Decile 8, 9, 10
Without Fixed Effects With Fixed Effects
N 72 72
Log Likelihood -31.09 -5.944E-8
Likelihood Ratio 24.73 86.92
Aldrich-Nelson 0.26 0.55
βai 0.0372 (t=0.51) 2.1517( t=0.19)
βDMA 1.5268***( t =3.56) 56.5862***(t=15.74)
βregs -0.0910*( t=-1.64) -3.3795(t=-0.13)
βvol -0.1113( t=-0.47) -1.1287 (t=-0.08)
βliq 0.0606( t= 0.78) -1.6398(t=-0.04)
βFDI 1.8022* (t=1.96) 37.6652***(t=141.53)
α -2.2170 ( t=-1.31) -9.3265***( t=-2.59)

βexch N/A 16 out of 23

50
 Table 10 Simultaneous Equation System Estimates

Panel A: Prob(RTS) Equation

Deciles Group βAI βDMA βregs βvol βliq βFDI βexch Α

4,5,6,7 N: 96 0.9138*** 1.5227*** -0.0600 0.0969 0.1094*** 1.0354*** 7/23 -0.7022***

ML LLH: -209 (t=6.27) (t=43.79) (t=-0.27) (t=0.42) (t=8.30) (t=39.19) (t=-20.19)

N: 72 0.6544*** 1.5227*** -0.0718*** -0.1033*** 0.1109*** 0.6186*** 1/23 -1.7417***

LLH: -89.3 (t=55.64) (t=406.53) (t=-5.46) (t=-7.48) (t=3.18) (t=2463.8) (t=-11.44)
1, 2, 3
ML

8, 9,10 N: 72 0.5512*** 2.3054*** -0.0883*** -0.1247** 0.0058 0.9240*** 6/23 -0.3590***

ML LLH: -175. (t=8.77) (t=12.15) (t=-8.07) (t=-1.94) (t=0.26) (t=184.19) (t=8.31)

Panel B: Integrity (AI) Equation

Deciles Group βspr βcall βDMA βProbRTS βRampReg βvol βexch α

4,5,6,7 N: 96 -0.0269 -0.2287*** -1.3116*** 1.6521*** 0.0147 -0.4314 2/23 -3.3295***

ML LLH: -209.3 (t=-0.15) (t=-3.60) (t=-3.66) (t=4.73) (t=0.04) (t=-1.42) (t=-3.44)

1, 2, 3 N: 72 0.2297* 0.3458 -0.8107** 0.1364 -0.0005 -0.3078 3/23 -1.8397*

ML LLH: -89.33 (t=1.74) (t=0.98) (t=-2.35) (t=0.39) (t=-0.01) (t=-1.34) (t=-1.91)

8, 9,10 N: 72 -0.1803 0.3619 0.0074 -0.6112 -1.319** -0.0826 2/23 -3.3267***

ML LLH: -175.8 (t=-1.11) (t=0.64) (t=0.01) (t=-0.93) (t=-2.18) (t=-0.43) (t=-3.49)

51
 Panel C: Efficiency (Quoted Spread) Equation
Deciles Group βcall βProbRTS βRampReg βvol βregs βexch α

4,5,6,7 N: 96 -0.9427* 2.6807*** 7.7208*** 0.1463 -0.5519** 20/23 2.4904***

ML LLH: -209.3 (t=-1.61) (t=2.63) (t=2.77) (t=0.52) (t=-2.24) (t=2.80)

1, 2, 3 N: 72 -2.4053*** 7.9109*** 18.5797*** -0.2018 -1.9436*** 13/23 3.2416***

ML LLH: -89.3 (t=-9.83) (t=11.36) (t=11.11) (t=-1.34) (t=-6.31) (t=5.41)

8, 9, 10 N: 72 -5.1504*** 11.5069*** 21.8500*** -0.0660 -1.4930*** 20/23 0.6328

ML LLH: -175.8 (t=-9.97) (t=8.83) (t=8.31) (t=-0.61) (t=-7.76) (t=1.19)

52
 Figure 1, Panel A
A Marking the Close Alert

Figure 1, Panel B
A Ramping Alert

5.

53
View publication stats

Figure 2 Histograms for Spread Measure before and after log transform

54