INSIDE TRADERS

Inside Traders

Introduction1

Inside Traders Making Abnormal Returns1

Impact of Inside Trading2

Investors2

Financial Markets and its Efficiency2

Empirical Evidence3

Conclusion6

References8

Appendix9

Inside Traders

Introduction

Inside trading is the buying and selling of a financial security by anyone who has access to information that is not publicly available. This could result in an advantage to the person who has access to such information, in turn injuring others. Inside trading can manipulate the stock prices through publication of false or intentional creation of good or bad news, delaying the announcement of information to the public and creating an artificial market price by buying and selling of stocks (Manne, 1966, p.147).

Insider trading can be used in an illegal way and also a legal way. When the information is not made publicly available and is taken advantage of, then in such instance this practice is illegal; while on the contrary when the data is available to the public and trading is done under such circumstances then it is legal. Insider trading can have an adverse effect on the financial markets and their efficiencies.

Inside Traders Making Abnormal Returns

The inside traders are subject to making significant gains when they have inside news that could affect the prices of a financial security. There are several models that predict that the prices of a stock or any other security rise when insider traders are present in the market. The effect of this is seen when the trading volumes created by less informed traders do not increase because the inside traders buy or sell a security on a higher probability of risk of losing money. The market becomes less liquid due to this (Bagliano et. al, 2011, p.2).

Another reason due to which insider trader makes abnormal returns is because of the availability of information present in other sources. The rumours in the press or the speculative news about the company's performance can contribute to the gains of an insider trader. It is also seen that excess returns are observed just prior to the day of announcement of the news (John and Lang, 1991, p.1362).

Impact of Inside Trading

Investors

Investors are the shareholders that invest their money in the company for a long period of time. They do so by buying shares of the company and holding onto them. Insider trading effects investors, as the information being provided the investors may not contain all the facts which could impact their returns on their investment.

Insider trading has a very adverse effect on the profits that the investors make through trading, which is when they sell the shares which they were holding. The incentives that the managers receive from the investors are also affected; they would be getting reduced compensation.

Financial Markets and its Efficiency

Insider trading has a negative effect on the functioning of financial markets. The market liquidity is impacted the most along with prices and trade volumes (Fishe and Robe, 2004, p.462).

The strong form of market efficient hypothesis assumes that the availability of information is very important for a market to ...