October 01, 2002
Article in Handbook of World Stock, Derivative & Commodities Exchanges
By Michael Aitken and Carole Comerton-Forde
Capital Markets Co-operative Research Centre and Securities' Industry Research Centre of Asia Pacific.

Executive summary

This article examines trading behaviour in seven equity markets with the aim of identifying evidence of possible 'window dressing'. Window dressing is a deliberate strategy of price manipulation where the price of a security is increased significantly at the end of the trading day, in particular at month and quarter ends.

The basic motivation for window dressing, often attributed to fund managers, is to increase the price of securities in which their funds have relatively high exposure, in order to improve the performance of their funds under management. Given that fund performance is often measured using the month-end closing price, we focus here on these days and times. While it is recognised that there are incentives for window dressing on alternative days, such as option and future expiry days, an examination of these days is left to future research.

We examine the period April 2000 to September 2000 and concentrate on the top 150 securities by trading activity. Notwithstanding the exclusion of smaller securities, this represents between 72% (Nasdaq) and 100% (Oslo Stock Exchange) of the market trading activity. The liquidity of the securities examined varies significantly across the different markets. The Nasdaq is the most liquid with an average of 5,918 trades per day for the sample and the Oslo Stock Exchange is the most illiquid with an average of 63 trades per day for the sample.

Our main findings are:

• The Australian Stock Exchange has the highest incidence of window dressing over the period with an average of almost 10 securities being window dressed each month, although it also displays the lowest average percentage change in price for these securities.
• Hong Kong Exchanges exhibits the lowest incidence of window dressing, with an average of three securities being window dressed each month.
• The Oslo Stock Exchange displayed the highest average return for window dressed securities with an average value of 8.65%.
• The Nasdaq showed an equal number of instances of window dressing on month-end and non-month-end days suggesting that further research should consider other incentives for window dressing in this market.
• Window dressing is not typically concentrated in a particular group of securities. In the eight markets examined there are only five securities that were window-dressed on more than two occasions.
• Window dressing is relatively evenly distributed across the securities with different levels of liquidity. However, this may be due to the fact that only the top 150 most liquid stocks in each market have been included in the analysis.

Introduction

This article examines prima facie evidence of window dressing across seven different securities markets: the Australian Stock Exchange (ASX), Hong Kong Exchanges and Clearing (HKEX), the London Stock Exchange (LSE), the Nasdaq Stock Market (Nasdaq), the Oslo Stock Exchange (OSE), the Singapore Exchange (SGX), and the Toronto Stock Exchange (TSE).

There is no legal or generally accepted definition of window dressing. However, the term is commonly used to describe situations where the price of a stock is increased significantly at the end of a trading day, particularly at the end of a month. Window dressing is typically thought to occur as a result of the actions of fund managers attempting to increase the price of securities in which they have a large exposure. The incentive to manipulate comes as a direct consequence of fund and fund manager performance being assessed at this time.

We define window dressing as a situation where the increase in the price of a stock in the last 15 minutes of the trading day is greater than the top 1% of price changes for that stock during the previous month.

The high level of concern about window dressing is apparent in recent decisions by a number of exchanges to implement special mechanisms for the determination of closing prices. These mechanisms are typically aimed at making it more difficult for investors to influence the closing price. For example, the ASX and SGX have implemented closing call auctions. An alternative approach is to use a special algorithm to determine the closing price rather than using the last trade price. The HKEX and the Madrid Stock Exchange take this approach. The New Zealand Stock Exchange takes a slightly more novel approach and closes the market randomly between 15:25 and 15:30 each day. The effectiveness of these mechanisms is an interesting source of research. In particular it would be worth studying whether these changes have any effect on the practice of window dressing. However, here we simply attempt to confirm whether the incidence of the practice is apparent.

We examine differences in the frequency of window dressing across various markets, in particular focusing on whether window dressing occurs more frequently on month-end days. We also consider whether particular securities are more susceptible to window dressing. Future research should extend the time period examined in order to consider whether securities are more likely to be manipulated in particular months (i.e. quarter ends). It might also seek to gain access to trust deeds to establish the precise dates and mechanisms used to assess fund and fund manager performance. This would allow a closer examination of the impact of fund managers on particular dates.

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