Abstract:
Allen and Gale (1992) construct a model to show that stock price manipulation is possible. The time structure of
their model allows manipulators to pretend as “informed” traders, so that the local investors cannot distinguish
what type of entrant they are facing. When the type of the entrant becomes known to the local investors it is
already too late to make any use of that information. This paper shows an institution can be designed in a
very natural fashion which induces different behaviors on the part of manipulators and “informed” traders at the
beginning of the process. The institution designed roughly consists of entitling the entrants to resell stocks at a
later date as well if they wish to do so. As this reasoning is also accessible to manipulators, the designed
institution deters them from entering the market. Regarding the informed traders, their expected gain from
entering the stock market may or may not be positive contingent on the basic parameters of the model. There
are cases, however, when there is an improvement in the expected total gain of the local investors.