Frauds in finance: Prevalence, determinants, and consequences
- Publication Type:
- Thesis
- Issue Date:
- 2024
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There is hardly any activity in finance untouched by fraud and misconduct. This dissertation investigates different aspects of financial fraud. It covers deceptive practices of financial advisers, market manipulation, cryptocurrency-related scams, and investigates whether investors falling victim to scams learn from their mistakes.
Chapter 2 shows that up to 30% of financial advisers in the U.S. are involved in misconduct, but only one-third of these cases are reported by regulators. Advisers with a high propensity for misconduct oversee approximately $6.9 trillion assets under management (AUM). The rates of adviser misconduct and unreported cases increase during the GFC, paralleling the decline of trust in financial institutions. This chapter also provides a list of characteristics for consumers, advisory firms, and regulators to help identify adviser misconduct.
Chapter 3 investigates the real economic consequences of market manipulation. Increased manipulation makes stock price signals less useful for firm managers seeking to learn about potential investment opportunities, thereby decreasing the sensitivity of firms’ investments to stock prices. This leads to a decline in the quality of firms’ investment decisions, and consequently, firm operating performance also decreases.
Chapter 4 analyzes how public blockchains have given rise to a new type of scam known as a “rug pull” and finds these scams are pervasive: 44% of tokens in major decentralized exchanges (DEXs) are scams, causing losses of $1.5 billion to investors. This chapter shows that scams differ from legitimate tokens in key characteristics. Using these characteristics, Chapter 4 develops a scam index that can predict cryptocurrency scams, with practical applications in cryptocurrency surveillance.
Based on methodologies developed in Chapter 4, Chapter 5 analyzes investors’ trading behavior and investment approaches after falling victim to scams. Experiencing a scam in the recent past decreases the probability of investing in a scam again. However, experiencing a scam also decreases subsequent non-scam investment returns. Victims increase their portfolio values, but the cash allocation and the standard deviation of daily portfolio returns suggest that victims become more (resp. less) risk-tolerant in the short (resp. long) term after being scammed.
Overall, this dissertation quantifies and characterizes different forms of frauds in finance. Understanding how these fraudulent activities work, how common they are, what leads to them, and their consequences are important for designing effective surveillance tools, protecting consumers, designing better markets, maintaining trust in the broader financial system, and more generally, improving overall welfare in society.
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