Spoofing in Equilibrium

Abstract

We present a model of dynamic trading with exogenous and strategic cancellation of orders. We define spoofing as the strategic placing and canceling of orders in order to move prices and trade later in the opposite direction. We show that spoofing can occur in equilibrium. Consistent with regulator concerns, we show that spoofing slows price discovery, raises bid-ask spreads, and raises return volatility. A novel prediction is that the prevalence of equilibrium spoofing is single-peaked in the measure of informed traders, suggesting that spoofing should be more prevalent in markets of intermediate liquidity. We consider within-market and cross-market spoofing and discuss how regulators should allocate resources towards cross-market surveillance.

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