Large Investors, Price Manipulation, and Limits to Arbitrage: An Anatomy of Market Corners Franklin Allen*, Lubomir Litov**, and JianPing Mei*** Draft of 11/3/2004 Abstract Using a hand-collected new data set, this paper investigates price and trading behavior around several well-known stock market corners occurred between 1863 and 1980. We find strong evidence that large investors possessed market power that allowed them to manipulate prices. Manipulation leading to a corner tends to increase market volatility and has an adverse price impact on other assets. We also find that the presence of large investors makes it extremely risky for would-be short sellers to trade against the mispricing. Therefore, regulators need to be concerned about corners since they are accompanied by severe price distortions and liquidity erosion. JEL Classification: G14, G18, K22. Keywords: Manipulation; Market Corner; Limits to Arbitrage. * Nippon Life Professor of Finance and Professor of Economics, Department of Finance, The Wharton School of the University of Pennsylvania, Philadelphia, PA 19104-6367, phone 215-898-3629, fax: 215-573-2207, email:
[email protected]. ** Doctoral student, Leonard Stern School of Business, New York University, New York 10012, phone: 212-998- 0883, fax: 212-995-4218, email:
[email protected]. *** Associate Professor of Finance, Leonard Stern School of Business, New York University, New York NY 10012 and CCFR, phone: 212-998-0354, email:
[email protected]. We are grateful to Niall Ferguson, William Goetzmann, Richard Sylla, Jeffrey Wurgler, and conference participants at the CEPR Conference on Early Securities Markets at the Humboldt University for valuable discussions.