The dollar cost of insider trading and market manipulation left global markets US$3.4 billion the worse for wear, according to Australian financial think tank Capital Markets Co-operative Research Centre (CMCRC).
“This breaks down to an average of US$401 million in each North American market, US$31 million in each European market and US$165 million in each Asia Pacific market, or 0.02%, 0.03% and 0.04% of turnover respectively,” said Professor Michael Aitken, chief scientist at CMCRC.
Globally, 21 markets were included in Aitken’s study – three in North America, seven in Europe and 11 in Asia Pacific.
Aitken calculated the average cost of market manipulation in Q2 at US$88m for each North American market, US$41m for each European market and US$33m for each Asia Pacific market, suggesting that over the last quarter, market manipulation was less significant than insider trading.
To calculate the effects of prohibited trading activities, Aitken used information leakage as a proxy for insider trading. To deduce the cost of market manipulation, he analysed price and volume at the end of each trading day and at the end of each month, in an attempt to identify patterns. He added that a dislocation, or unusual movement, of end-of-day price was one commonly used indication of market manipulation.
He also believed he was able to measure the efficiency of a market using a combination of implicit trading costs and price discovery.
For Q2, the North American implicit costs were six-to-seven basis points (bps), compared to 11 bps in Europe and 30 bps in Asia Pacific.
“Efficient markets are cheaper to trade in,” he said.
Analysing historical data from 2006 onwards, Aitken said the cost of market manipulation and insider trading could be as little as 0.5 bps.
“Most people would think that 0.5 bps was surprisingly low and would have expected the cost of insider trading to be much more substantial and costly,” he said, explaining that the figure was his calculated cost of information leakage, which would be the maximum insider trading could possibly be, as not all information leakage could be attributed to insider trading.
Aitken believed his analysis was the first attempt to quantify market integrity by estimating the dollar cost of prohibited trading behaviours.
“If you can come up with a measure, then every time a regulator feels the need to react to market events by designing new laws, it can analyse that need with objective measures,” he said.
Earlier this year, when France, Spain, Italy, Belgium and Greece banned the short selling of certain financial securities, Aitken analysed his European data and found that market effectiveness and integrity actually declined.
“This suggests that the ban on short selling resulted in a less effective market with lower integrity,” he said. “If you have a market which is more susceptible to manipulation, that market will also be dearer to trade in – some 25 to 50 times dearer.”