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  • Academic Research on Insider Trading

    Posted by Carl from Chicago on May 28th, 2011 (All posts by )

    In today’s Barron’s magazine there is an article titled “Keeping One Step Ahead of the News“. The article summarizes an academic study by Nitesh Sinha (University of Illinois at Chicago). Barron’s tagline was:

    A provocative new academic study suggests the government should scrutinize options trading for hints of insider trading. Volume seems to arrive before the news does.

    The study took researched how the options market behave before “surprise” news came out. They took two incidents involving Baxter International and Bank of America and showed that option volume increased by a factor of more than 500 prior to the news coming out, which was obviously sign of something interesting occurring (if it can be replicated on a larger scale). Generally the SEC seems to go after stock trading rather than the options market for insider trading, but per the authors there are a lot more ways to trade on information in the options market and it is also easier to “short” bad news (just buy a put) when for the cash market you actually need to “short” the stock which is more complex.

    It is important to realize that these sorts of researchers actually DO find major items that the SEC misses from time to time; the “options backdating” scandal (where executives chose the most advantageous day where the price was lowest as the date of issuance for their options) was broken by researchers and not the SEC itself. It will be interesting to see if this study can be extended or similar ones launched and how far these investigations go. Unlike the options dating scandal where the companies themselves were charged in this case if you see an strange event like a bump in trading they would have a lot of work to do in order to determine who profited and why and whether or not it was based on insider information.

     

    6 Responses to “Academic Research on Insider Trading”

    1. Paul Milenkovic Says:

      Right after the 9-11 attack there was some speculation or rumors about unusual trading activity beforehand. Didn’t anyone ever follow up on that or is that one of those Urban Legends that there were any trading shennanigans associated with the terrorists?

    2. renminbi Says:

      There were people who bought pits in Airline stocks beforehand. This was looked into and declared harmless, IIRC.

    3. Jonathan Says:

      My unevolved opinion on this topic is that most “insider trading” is a victimless crime, that real insider trading — breaches of fiduciary duty by corporate insiders — can be readily dealt with by civil litigation, and that the respective financial incentives facing traders and regulators make govt attempts to police complex trading activity a fool’s errand. Financial markets are rough neighborhoods and always will be. The govt’s rules often don’t make sense (e.g., insider trading is arbitrarily allowed in some markets but not others). Better to deregulate and warn the public to be careful, than to try to micromanage things as is done now.

    4. PenGun Says:

      The ponzi scheme you call the US economy is crooked in almost every way possible. Insider trading is a tiny part of what’s wrong with it.

      With both your political parties are owned by just a few people who control “wealth” in your country there will be very few changes. This will not save your sorry asses from what is coming.

    5. Robert Schwartz Says:

      Larry Ribstein, who is a law prof at UIUC, would agree with you Jonathan. He thought the “backdating” cases were laughable http://truthonthemarket.com/

      For myself, I have long believed that the SEC is engaged in an elaborate kabuki, that is completely useless. Their premise is that an investor, relying solely on documents, such as the annual report and proxy statement, can make an investment decision that is on a par with other market participants, such as i-bankers and the squads of analysts, or with corporate insiders.

      The proposition is ridiculous. Individual investors should invest in index funds and leave the mayhem to the pros.

    6. Nitish Sinha Says:

      Actually we extended our examples to 135,000 news events and find the results similar and statistically significant. Notice the chart on the second page of the article. Thanks for mentioning the work and believing that it has value.