Stealth Trading, Price Manipulation and Investor Types in the Emerging Taiwan Equity Market

Abstract

In line with the stealth trading hypothesis advanced by Barclay and Warner (1993), Chakravarty (2001) and Chakravarty, Van Ness and Van Ness (2005), this paper extends the test of fragmentation of trades for different types of investors in the Taiwan stock market – a pure order-driven emerging market. The trade-size clustering is investigated through a longitudinal analysis of the comprehensive tick data for Taiwan’s equity market from 1998/1/2 to 2006/12/31. We test the public information hypothesis that the stock price change associated with a release of public information that will occur on a trade of a given trade-size category is directly proportional to the percentage of trades in that category. Such a proposition goes against the stealth trading hypothesis which suggests that there is a disproportional association between the percentage cumulative price change and trade-size. To mitigate the research biases resulting from the deregulation of foreigners’ holdings during the study period, the sample is divided into three periods according to the investment caps for foreign investors in Taiwan for performing these tests (30%: 1998/1/2-1999/3/31, 50%: 1999/4/1-2000/12/31, no limit: 2001/1/2-2006/12/31). The empirical results indicate that, regardless of what type the investor is, most of the cumulative price changes are affected by small- and medium-size trades. By comparing the per percent volumes of cumulative absolute price changes for different institutional investors with individual investors, we further confirm that the extent of stealth trading inherent in institutions is much more intensive than it is for individuals. The clustering of the per percent trades of cumulative absolute price changes for large-size trades reveals the existence of trade-intention-induced price manipulation in Taiwan. The fact that the per percent trades of cumulative absolute price changes for large-size trades of institutions are significantly greater than those for individuals confirms the influence of institutional investors on price volatility. For the fully deregulated period (2001/1/2 – 2006/1/2), we find foreign institutional investors to be the most influential investors in Taiwan, even though they disguise their intention to trade. Our result is consistent with the prediction of Barclay and Warner, and Chakravarty’s stealth-trading hypothesis. While making the most of the information advantage, the institutional investors in Taiwan appear to engage in trade-intention-induced price manipulation in addition to stealth-trading behavior. The finding of the trade-intention-induced price manipulation of this paper is similar to the previous one, but different from the stark-naked phenomenon of the large block trade/ price manipulation in China’s stock market found in Cai, Cai, and Keasey (2006). Our findings appear to further confirm the market lore that institutions are informed traders.