ForensicFinance (1)

ForensicFinance (1) - Forensic Finance Jay R. Ritter May...

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1 Forensic Finance Jay R. Ritter May 2008 Forthcoming, Journal of Economic Perspectives Jay R. Ritter is Cordell Professor of Finance, Warrington College of Business Administration, University of Florida, Gainesville, Florida. His e-mail address is <[email protected]>.
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2 During popular prime-time television shows, forensic investigators use specialized but wide-ranging scientific knowledge of chemical trace evidence, bacteria, DNA, teeth, insects, and other specialties to collect and sift evidence of possible crimes. In economics and finance, forensic investigators apply their own specialized knowledge of prices, quantities, timing, and market institutions—and sometimes discover or substantiate evidence that is used by regulatory or criminal enforcement agencies. One early episode in forensic finance was discussed in this journal in 1995. In their article, William Christie and Paul Schultz describe how they began a research project to look at intra-day patterns in spreads between bid and ask prices on the Nasdaq market. At this time, bids and asks were quoted in increments of one-eighth of a dollar. However, they noticed that in their data, stocks were quoted almost exclusively in even-eighths. As they write: “In other words, quotes rarely used any of the one-eighth, three-eighths, five-eighths, or seven-eighths price fractions. We checked whether we had made any errors in downloading the data, but found none. We checked our programs, and found no code that could have produced such a bizarre result. We turned to an alternative data source … the results were identical. We were stunned. It seemed inconceivable that almost 60 market makers simply forgot to use one-half of the possible price fractions for a period of almost two months.” They wrote that that this pattern offered strong circumstantial evidence of implicit collusion between brokerage firms making markets in Nasdaq stocks. Their research led to regulatory investigations by the Securities and Exchange Commission and class action lawsuits that were settled for over $1 billion. Moreover, the practice of quoting in even-eighths ended quite abruptly as soon as their results were publicized.
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3 Of course, not all subjects in forensic finance arise out of what Christie and Schultz (1995) called “serendipity in the social sciences.” In some cases, academics have been the first to identify a practice. In other cases, regulators or financial journalists have identified isolated situations and an academic study has been a catalyst for raising the level of attention. In general, practitioners, journalists, and regulators often have better knowledge of anecdotal evidence, whereas academics can provide large-sample evidence of patterns. In this article, I will discuss four recent topics in forensic finance, all of which have
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This note was uploaded on 02/17/2012 for the course FIN 4504 taught by Professor Banko during the Spring '08 term at University of Florida.

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ForensicFinance (1) - Forensic Finance Jay R. Ritter May...

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