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20 Jul 2006
I've been reading some of the very interesting papers from the Fifth Workshop on the Economics of Information Security, (WEIS 2006), held last month in Cambridge (UK). Rainer Boehme and Thorsten Holz's paper The Effect of Stock Spam on Financial Markets is the first analysis I have seen of pump and dump spam, and comes to the dismaying conclusion that it works.
Pump and dump is a financial scam that predates the Internet by decades if not centuries. The promoter buys up some stock in a small thinly traded company, then touts it to get the suckers to buy it, which drives up the price so he sells. Spam is an ideal medium for the touts, and since historical stock prices are easily available, this is one of the few kinds of spam where there is data that makes it possible to see what the effect was.
There have been pump and dump sites for quite a while that show that only a fool buys the touted stocks, but this analysis looks at the volume of touted stocks and the short term price changes, to see if the intended price jump happens. The statistical analysis to extract useful info from the noisy data is rather complicated. They use the notion of abnormal returns to try to isolate the price changes that aren't explained by the normal behavior of stocks. They found a mean abnormal return of +1.7% the day of the spam, then -0.9% the next day, then +0.9%, -1.1%, and -0.9% the next three days. So if you already own the stock before the spam is sent and sell it within a day or two, you will make a small but consistently positive amount of money.
They have some other observations on naive recipients who believe the spam and smart recipients who know what's going on but try to get in on the price jump, and other possible uses of fake financial advice such as trying to trigger a run on a bank by spreading rumors of its insolvency. It's worth wading through the arithmetic.
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