Thursday, June 29, 2006

How easy is it to manipulate a financial market?

A lot of people in India believe (a) that market manipulation is easy and (b) that it happens all the time.

An excellent blog entry by Michael Stastny offers some good reasoning on the issues. The key insight is to distinguish between the ease with which a price can be distorted by a manipulative cartel and the ease with which the cartel is able to walk away holding profits. In the past, I have called this `the Abhimanyu problem' (if this literary allusion means nothing to you, that's okay). It's easy to walk into a large long position, with a huge MTM profit. It's enormously more difficult to walk out with no position and clean cash.

Market manipulation is a business, and the basic rules about entry continue to hold. If market manipulation were an easy business offering supernormal rates of return, there would be a flood of entry, and a lot of people would plunge into doing it!

The thought process about position limits needs to be illuminated by such reasoning.

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