Does Contracts Size Matter? Essay

2115 words - 8 pages

The Common perception about the word ‘insider trading’ is that all insiders’ transactions are illegal. This misperception arises because some trades by insiders are illegal while others are absolutely legal. In this study, we study insider trading transactions those are perfectly legal, where the information of these trades is publicly available.

The insider trading issue not only attracts finance literature (see, e.g., Lorie and Niederhoffer (1968), Jaffe (1974), Seyhun (1986, 1998), Rozeff and Zaman (1988), Lin and Howe (1990), and Lakonishok and Lee (2001). but also attracts law and economics literature (see, e.g., Manna (1966), Georgakopoulos (1993), and Carlton and Fischel (1983)). After extensive study of literature on insider trading, we find the following three motivations to study reported insider trading

Science After the classic paper of Fama (1970), everybody debates about the stock market efficiency. The reported insider trading transactions provide us an opportunity to measure market reaction (semi-strong efficiency) around the day of reporting of insider trades, which has scientific implications of insider trading on market efficiency.

Optimal trading Strategies Investors or traders use various trading strategies to obtain excess returns, for example, the value-based strategy or the contrarian strategy. These strategies use fundamental factor to market price ratios, for example, book to market ratio (B/M) or earning to price ratio (E/P) ratio, to identify the factors that make above market returns. When stocks and companies data are freely available to money managers or traders, then it is hard to find a particular trading strategy that is profitable over others. Can the information content of insider transactions improve our trading style? Where does insider trading information fit in these optimal trading strategies? As we know, insiders are the most informed investors in the stock market. Thus, by mimicking their actions, can we beat traditional trading strategies? Profit hopes motivate us to develop optimal trading strategies by following the steps of insiders.
Public Policy Stock market regulators always give their effort to establish a fair and efficient stock market where no one has access of unpublished price sensitive information while trading. The informed trading increases the adverse selection cost to outsiders (Stoll, 1989), which may have adverse impact on the liquidity of the stock market. Do insiders pursue information advantage over other investors? Stock market regulators always try to solve this puzzle. Thus, the implication of this study also attracts the attention of stock market regulators to determine an effective insider trading regulation.
It can fairly be said that an investor considering an investment decision (whether to buy, sell or hold stock) in a publicly traded firm acts on the extensive information that is made available by the firm to him until the last moment...

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