price manipulation in indonesian capital market: empirical

132 - Manajemen Usahawan Indonesia Vol. 41 No.2 | Maret - April 2012

Price Manipulation in Indonesian Capital Market:Empirical Analysis on Stockbroker’s Behavior and Interaction Pattern Between Domestic Investor and Foreign Investor

Price Manipulation in Indonesian CapitalMarket: Empirical Analysis on Stockbroker’sBehavior and Interaction Pattern BetweenDomestic Investor and Foreign InvestorBuddi Wibowo

ABSTRAK

Manipulasi harga dalam transaksi pasar modal merupakan masalah pentingketika pengembangan kepercayaan investor dan integritas pasar menjadi suatuyang prioritas. Manipulasi harga lazim di pasar negara berkembang yang masihmemiliki masalah kelembagaan dan kurangnya peraturan. Pasar saham sebagaireksadana memiliki masalah kelembagaan ketika broker saham bukannyaberperilaku sebagai perantara, mereka seperti dealer dan prinsipal untuk beberapasaham. Broker saham memiliki motivasi kuat untuk memberikan sinyal kepadainvestor publik tentang harga beberapa saham agar mendapatkan keuntunganyang tidak adil. Kenaikan harga artifisial dibuat dengan melakukan pembeliandan penjualan di antara mereka sampai investor pemburu rente mengikutipermainan mereka. Ketika harga saham berada pada tingkat tertinggi, paramanipulator tadi mulai menjual sahamnya. Penelitian ini akan mengukur danmengidentifikasi pola perilaku pialang saham di Bursa Efek Indonesia terkaitkontribusi mereka pada manipulasi harga. Karena adanya peran penting investorasing di pasar saham Indonesia, penelitian ini juga akan mengidentifikasi polainteraksi antara investor asing dan domestik. Penelitian empiris menunjukkan,investor asing berkinerja lebih rendah dibandingkan investor domestik di pasarsaham Indonesia (Dvorak 2005, dan Agarwal et al. 2009). Meskipun memilikikelebihan pengalaman dan dukungan keuangan dibandingkan investor domestik,investor asing mendapat return rata-rata lebih rendah. Agarwal et al. (2009)menunjukkan fenomena ini terjadi karena investor asing lebih agresif dariinvestor domestik. Dvorak, (2005) berpendapat bahwa investor domestik memilikilebih banyak akses dan jaringan untuk mengumpulkan informasi jangka pendekdan mampu mentransfer informasi tersebut bagi strategi perdagangan yangmenguntungkan. Penelitian ini menguji hipotesis baru tentang rendahnya kinerjainvestor asing, bahwa investor asing telah terjebak oleh mekanisme manipulatifyang dilakukan investor domestik karena memiliki informasi jangka pendekmelalui perusahaan pialang saham domestik.

KATA KUNCI: Manipulasi harga, pasar saham, broker saham, Bursa Efek Indonesia

Manajemen Usahawan Indonesia Vol. 41 No. 2 | Maret - April 2012 - 133


ABSTRACT

Price manipulation in stock market transaction is an important issue when develop-ing investor confidence and market integrity is a priority. Price manipulation isprevalent in emerging markets which still have institutional problems and lack ofregulations. Stock market as a mutual company has an institutional problem whenstock broker instead of being a intermediary, they behave like a dealer and aprincipal for some stocks. Stock broker has a strong incentives to give a signal topublic investor about price of some stocks in order to get an unfair profit. Usualpattern of manipulation done by stock broker is a pump and dump manipulation.Artificial price increase was made by manipulators through buy and sell amongthemselves until tend chaser and naive investor jump to this game. When stock priceis at the highest level, manipulators start selling their stock. This research willmeasure and identify behavior pattern of stock broker in Indonesia Stock Marketconcerning their contribution in price manipulation existence. Because of impor-tant role that play by foreign investors in Indonesian stock market, this research willalso identify interaction pattern between foreign and domestic investors. Empiricalresearches showed that foreign investor was underperformed domestic investor inIndonesian stock market (Dvorak, 2005, and Agarwal et al. 2009). In spite of theirsuperior experience and financial support compared to domestic investor, foreigninvestor got lower return on average. Agarwal et al. (2009) show this phenomenonoccured because foreign investors are more aggressive than domestic investors.Dvorak, (2005) argue that domestic investors has more access and network to collectshort run information and are able to transfer those information to profitabletrading strategy. This research test new hypothesis about foreign investorunderperformance, that those foreign investor was entrapped by manipulativemechanism done by domestic investor that have short run information throughdomestic stockbroker company.

KEYWORDS: Perice manipulation, stock market, stockbroker, Indonesia StockMarket

* Buddi WibowoStaf Pengajar Departemen Manajemen Fakultas Ekonomi Universitas Indonesia (FEUI) dan Peneliti padaLembaga Management FEUI; menyelesaikan pendidikan S3 bidang Manajemen Keuangan pada ProgramPascasarjana Ilmu Manajemen FEUI, tahun 2009. Alamat Kontak: Fakultas Ekonomi UniversitasIndonesia, Kampus Universitas Indonesia, Depok 16424, Jawa Barat, telp: 021-727 2425, 727 2646, fax:021-727 0024. Email: [email protected]



1. INTRODUCTIONStock market manipulation is a kind of

deception through developing an artificialstock price. This manipulative action is usuallydone by some investors and brokers whomake artificial transactions among themselvesin order to increase stock price. Naive inves-tors who are attracted by this increasingtrend of the stock price will follow this trendand make price increase further. These naiveinvestors will enter the market until the priceget so high and the manipulators start sellingthe stock. Profit taking activities get the priceto decrease until its real value. This manipu-lative action is called as pump and dumpmechanism ( Allen dan Gale, 1992).

This market price manipulation usuallyoccurs at stock markets in developing coun-tries which are not already backed by strongsupervising institution, system, and regulationthat can prevent this practice. Zhou dan Mei(2003) dan Khanna dan Sunder (1999) foundsources of manipulative stock transaction inChina dan India are weaknesses at supervisinginstitution and market regulation.

Low market integrity has an implicationon public motivation to invest in capital mar-ket. Market capitalization in developing coun-tries is relatively low compared to GDP. Num-ber of public company is low and just fewcompany go public every year. For exampleIndonesia’s ratio stock market capitalizationto GDP is around 48%, far below from ratio inSingapore 334% and in Australia that is 140%of their GDP. Figure 1 shows market capitali-zation per capita for some countries.

Institutional weakness in developing coun-tries is not surprising because most of themhas operated not very long. Institutional build-ing and market regulation is a phase thatdeveloped countries, like USA, had experi-

enced before (Gordon, 2000). Manipulativepractice that destructed market integrity andinvestor confidence had pushed US SecuritiesAct in 1934 that was specially aimed at elimi-nating those practices.

Khwaja dan Mian (2006) found that ma-nipulative action through pump and dumpmechanism mostly were done and back up bystock brokers. Instead of being an intermedi-ary, they became a principal of some stocksand influenced those stock price formationprocesses for their own interest.

In Indonesian capital market, like mostlyemerging markets, stock brokers role in priceformation process tend to be significant be-cause of weak market structure and regula-tion. Mostly emerging capital market run asa mutual company so that those market werefound and owned by pool of stock brokes. Itis predominantly broker-managed, i.e., amajority of the exchange’s board of directorsincluding the chairman are brokers. More-over, trading on the stock exchange can bedone only through licensed brokers.

Stock broker has a conflict of interest as amarket player and also as a owner. Indone-sian Capital Market Act 1998 stated thatindonesian capital market stock are only per-mitted to be owned by stock brokers. Inter-national trend show that global capital mar-ket has changed their market ownerhip struc-ture in order to increase governance andmarket integrity. External owner make thepolicy making process in that capital marketbecome more transparant. 80 % stock ex-change in the world has been demutualized.Demutualization is an important stage incapital market regime to decrease and pro-hibit market manipulation. Figure 2 showsstages of demutualization process.



2. LITERATURE REVIEWThe existing literature documents mixed

findings on the relative performance of for-eign and domestic investors. Grinblatt andKeloharju(2000) and Seasholes (2004) reportthat foreign investors are better traders,sincethey are better informed.They find evidencethat foreign investors generally outperformdomestic investors. Brennan and Cao(1997),Hau, 2001, Dvor¡a´k (2005), Choe, Kho,andStulz (2005), however,report the oppositefindings. Dvor¡a´k (2005) finds that domesticinvestors earn higher profits than foreigninvestors in the Indonesian market. Choe,Kho,and Stulz (2005) report that foreign in-vestors pay more than domestic investors forpurchases and receive less for sales in theKorean market. After investigating underly-ing reasons forforeign investors’poor perfor-mance, they find that foreign investors tradeat worse prices because prices tend to moveagainst them before they trade,indicatingthe poor timing of their trades.EventhoughDvor¡ a´ k (2005) and Choe, Kho,andStulz(2005) agree that foreign investors’ tradingperformance is inferior to that of domesticinvestors, their explanations differ. Dvor¡a´k(2005) attributes it to information disadvan-tage, while Choe, Kho, and Stulz (2005) relyon the poor timing of trades by foreigninvestors. Based on a much longer study pe-riod and more comprehensive data, Agarwalet al (2009) find that foreign investors on theJakarta Stock Exchange (JSX) pay 9 basis pointsmore than domestic investors when they buyand that they receive 14 basis points less thandomestic investors when they sell. These re-sults confirm the findings by Choe,Kho,andStulz (2005) and Dvor¡ a´ k (2005).

We hypothesizes that price manipulationsare done by mostly domestic investor be-cause of their relative better access on shortterm information. Foreign investorunderperformance are caused by their lack ofinformation which stock is being manipu-lated by domestic investor and domestic stockbrokers. Foreign investor were traped in pumpand dump mechanism. They bought stockswhen stock broker principalness to buy indexwas high (LL state in Figure 3) and sell stockswhile the manipulators were trying to dumpthose stocks (HL state).

3. METHODOLOGYPrice manipulation mechanism identifica-

tion in emerging market is a challenging re-search. There are some theoretical model thattry to explain how the manipulation works(Aggarwal dan Wu, 2006). The substantialbroker influence intimated and the concernby the market regulatory body that ‘‘brokersmostly act as principals and not as intermedi-aries’’ suggest that we should start by examin-ing trading patterns to see if this concern islegitimate. More generally, we want to iden-tify any unusual trading patterns, and a suit-able normality benchmark, given the context,is whether a broker is acting as an intermedi-ary for different outside investors.

We use the methodology that proposesby Kwaja and Mian (2006). Table 1 shows themethodology.



Suppose that the three types of principaltrades identified in Table 1 signify that thebroker is trading on his own behalf that day.The assumption that a principal trade alwaysreflects a broker trading on his own behalfdoes not need to be true all the time. All thatwe need is that principal trading is correlatedwith a broker trading on his own behalf.Then for each broker in a given stock, we cancompute the probability that a broker will doa principal trade. This is Khwaja and Mian’s(2006) measure PRIN. More precisely,

The subscript SB is added to reiterate thatPRIN is constructed separately for each bro-ker B in every stock S. Thus, in our example ofTable 1, Broker A has a PRIN value of 0:05 forthe 20 trades shown,10 and Broker B, a PRINvalue of 1.

Fig. 3 illustrates a stylized version of thismechanism but one that we believe reflectsreality reasonably well. We first classify eachstock-date with a state variable IBIS, where IBand IS refer to the overall PRIN category ofbuyers and sellers respectively trading thestock’s stock on that date. For simplicity,assume that I can take a H(igh) or L(ow) valuegiving four possible states for a given stock-date: HH, LH, LL, and HL. The state variable LHmeans that the average PRIN of the brokersbuying the stock’s stock that day is low,whereas the average PRIN of the brokers

selling the stock that day is high.16 The styl-ized mechanism works as follows. Start at apoint where prices are at their lowest (pointA). At this stage, manipulating brokers (withhigh PRIN) trade back and forth among them-selves (the state at point A is HHÞ to createartificial momentum and price increases inthe stock. This eventually attracts outsideinvestors with extrapolative expectations(positive-feedback traders) to start buying(branches B and C). However, once the pricehas risen enough, the manipulators exit the

market leaving onlyoutsiders to tradeamongst themselves(point D). The state

when price is at its highest is thus LL. Thisartificially high price cannot be sustained andeventually the bubble bursts (branches E andF) and the outside investors start selling. Onceprices are low enough, the manipulators canget back into the market to buy back theirstock at low prices and potentially restartanother pump and dump cycle (point G). Theabove mechanism is extremely stylized, and itis unlikely that it can be continuously used.Moreover, it relies on the existence of mo-mentum traders and assumes that groups ofbrokers get together to manipulate prices asopposed to an individual trader doing so.However, because we are testing for thismechanism directly, this also implies testingfor these assumptions.The mechanism im-plies that stock-date states can be used



DataWe use all daily transaction on all stock

from all stock brokers in Bursa Efek Indonesia(Indonesian Stock Exchange) since January2006 until Desember 2008. Principalnes tobuy and to sell was measured daily

4. RESULTS AND DISCUSSIONBefore we test relationship between

principalness index and foreign transactionpattern, we need to know the existence ofpump and dump mechanism. This manipula-

tive mechanism exists if there are price differ-ence between LL and HH stage. We formgroups of stock according to their volume oftransactions, number of transaction, returnvolatility, and principalness index. We findprice difference is significant in almost allcategory. We conclude that pump and dumpmechanism exist in Indonesian Capital Mar-ket. Table 2 shows the result.

We also test whether one can make profitby buying at HH state and sell at LL state. Theresult proves that hypothesis is true. Buy



stock at HH state and sell 1 week after thatgive 2,96% return, and decrease until 4 week.Table 3 and Figure 5 show the result

To test whether foreign investor was en-

trapped in pump and dump mechanism, we

test significance of volume difference be-

tween foreign buy transaction and foreign

sell transaction in the state of LL. If foreign

investor was entrapped, their buy volume

transaction was much higher than their sell

transaction in state of LL. The result is that

foreign investor buy transaction was, on av-

erage, 4,14 % higher than their sell transac-

tion for one week holding period but it is not

significant ( p value = 15,6%). For robustness

test, we classified the data by degree of

principalness and form ten groups. We find

that for all ten groups show foreign investor

tend to buy more but most of them are not

significant (level of error 5%). We can make

a conclusion that foreign investor were not

entrapped in a pump and dump mechanism.

5. CONCLUSION

There are indications that pump and dump

mechanism exist in Indonesian stock market.

Using Khwaja and Mian (2006) manipulation

definition and measurement, we find that pump

and dump mechanism occurred for around 4

week period from HH state that when principal

brokers start to pumping stock price until HL

state when those brokers sell systematically

their stock. This mechanism gave profit the

brokers around 2.96% (15.74%, annualized).

We also find that foreign investor was not

entrapped in this manipulative mechanism.

Even though we find that foreign investors’ net

buying was relatively high around the LL state,

but they are not statistically significant.



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ARTICLE IN PRESSZhou, C., Lai, J., (2009),Behavior based manipulation.

Journal of Empirical Finance

price manipulation in indonesian capital market: empirical

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