The Definitive Guide to Bear Raids

by StockJockey

Thursday, April 17, 2008 - 12:56 pm

Suspicions over the implosion of Bear Stearns continue to focus on a "bear raid"; what it is exactly?

Bear Raid--The illegal practice of attempting to push the price of a stock lower by taking large short positions and spreading unfavorable rumors about the target firm.

Was Bear's implosion the result of a semi-organized smear campaign? Maybe, maybe not, although I have not heard too many money managers bragging that they were short Bear's stock.

No one openly admits to conducting a "bear raid," since deliberately manipulating stock prices is illegal. But Wall Street has long believed bear raids can and do take place. There has, however, been little academic research to explain the forces at work. Now two finance experts have shed some light on the process. "We basically describe a theory of how bear raid manipulation works," says Wharton finance professor Itay Goldstein. TheStreet.com

Yes, several academics are trying to explain the ethereal concept of a bear raid:

Abstract:
It is commonly believed that prices in secondary financial markets play an important allocational role because they contain information that facilitates the efficient allocation of resources. This paper identifies a limitation inherent in this role of prices. It shows that the presence of a feedback effect from the financial market to the real value of a firm creates an incentive for an uninformed trader to sell the firms stock. When this happens the informativeness of the stock price decreases, and the beneficial allocational role of the financial market weakens. The trader profits from this trading strategy, partly because his trading distorts the firms investment. We therefore refer to this strategy as manipulation. We show that trading without information is profitable only with sell orders, driving a wedge between the allocational implications of buyer and seller initiated speculation, and providing justification for restrictions on short sales.

While I appreciate the academics putting in the time to study the subject, it remains a difficult theory to grasp. Bear raids are like pornography-you know it when you see it.

The seeds of Bear’s destruction were sown in the summer of 2007. The stock traded down to what had historically been a trough valuation, and then the ball really got rolling. By early March every downtick in Bear’s stock was being scrutinized, and a confluence of events, probably more driven by fear than greedy short sellers, finished off the company.

Bear raids remind me of Sasquatch. Although many traders and investors claim to have seen one, they have produced no proof. And quite frankly, I believe the only people who truly understand bear raids are the folks on the trading desks around the globe. They have a sixth sense that can only be developed by working in the business.

And while regulators are looking for signs of manipulation in Bears demise, they are likely to be a successful as Sasquatch hunters.

And much like the legend of Sasquatch, this rumor will likely never die.

Was Sasquatch short Bear Stearns?

‘Bear Raids’: How and When They Work, and Who Benefits
TheStreet.com

Manipulation and the Allocational Role of Prices
Research Paper
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