#06-02
Large Investors, Price Manipulation, and Limits to Arbitrage:
An Anatomy of Market Corners
Franklin Allen, Lubomir Litov and Jianping Mei, January 2006
Abstract: Corners were prevalent in the nineteenth and early twentieth century. We first develop a
rational expectations model of corners and show that they can arise as the result of rational
behavior. Then using a novel hand-collected data set we investigate price and trading
behavior around several well-known stock market and commodity corners which occurred
between 1863 and 1980. We find strong evidence that large investors and corporate
insiders possess market power that allowed them to manipulate prices. Manipulation
leading to a market 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 risky for
would-be short sellers to trade against the mispricing. Therefore, regulators and exchanges
need to be concerned about ensuring that corners do not take place since they are
accompanied by severe price distortions.
Keywords: Manipulation; Market Corner; Limits to Arbitrage.
JEL classifications : G14, G18, K22..
