Investment Spam Works!

A couple of months ago I was on the train from New York City. Since I'm what my friends call a "flaming extrovert", I started talking with the guy across the table from me (I was in the dining car working on my laptop). It turns out he was a "stock tout" who pushed microcap stocks using messages sent over the internet and over cell phones, and he seemed like a cross between a used car salesman, a typical New York wise guy, and Kramer ( Cosmo, not Jim).

It turns out there's a whole network of stock touts that work in concert to pump up the prices of these stocks. For a finance professor, it was really fascinating to hear about the activities of this group of players in the market that we generally either don't hear about at all, or dismiss as a bunch of hucksters. I though at the time that examining the activities of this group would make for a very interesting study. But since I don't do market microstructure research, I just filed it away as background info (and anecdotes) for the next time I taught about the stock market.

Now someone else has done a study: "Spam Works: Evidence from Stock Touts and Corresponding Market Activity" by Laura Frieder and Jonathan Zittrain. It turns out that the activities of these touts actually have significant effects on stock prices and volume:

We assess the impact of stock touting via unsolicited email upon the stocks' trading activity, and sketch how profitable spamming might be for those who manipulate stocks via spam as well as how harmful it is to those who might heed advice in stock-touting e-mails. We suggest that the profitability of spammed stock touting calls for adjustments to securities regulation models that rely principally on the proper labeling of information and disclosure of conflicts of interest in order to protect consumers.

Based on a large sample of touted stocks listed on the Pink Sheets quotation system, we find that stocks experience a significantly positive return on days when they are heavily touted via spam, and on the day preceding such touting. Volume of trading also responds positively and significantly to heavy touting. Indeed, on a day when no tout has been detected in our database, the likelihood of a touted stock being the most actively traded stock that day is only 6%. On the other hand, on days when there is touting activity, the probability of a touted stock being the single most actively traded stock is 81%. Returns in the days following touting are significantly negative. The evidence accords with a hypothesis that spammers "buy low and spam high," purchasing penny stocks with comparatively low liquidity, then touting them - perhaps immediately after an independently occurring upward tick in price, or after having caused the uptick themselves by engaging in preparatory purchasing - in order to increase or maintain trading activity and price enough to unload their positions at a profit. Selling by the spammer then results in negative returns following touting. Investors who respond to touting are losing, on average, 5.25% in the two day period following touting. For the quintile of stocks in our sample that are touted most heavily, this 2-day loss approaches 8%. These estimates are conservative, as they do not account for transaction costs.

Read the whole thing here.

The main takeaway I get from this is that the pink sheet market is something to be avoided at all costs. There's a whole lot of "pump and dump" activity going on there.

But ironically, on the SSRN page for the abstract, there are Google ads for a stock recommendation services.

HT: Professor Bainbridge