Stock Essay

1105 words - 4 pages

An active investor invests his all resources to determine the fair value of a stock. However, most of the times, he is unable to acquire a piece of information that is not available in the public domain and that information may alter the probability distribution of his investment decision (James Lorie, 1980). In this phenomenon, an active investor may infer the non-public information by considering corporate insiders’ action in their own stock. Many previous studies (e.g., Jaffe, 1974; Finnerty, 1976a, b; Seyhun, 1986, 1988a, b; Rozeff and Zaman, 1988; Lin and Howe, 1990) document that corporate insiders pursue special information and on that special information, not only insiders are able to earn abnormal profits through trading stocks of own firms but also outsiders also able to earn abnormally by merely mimicking their actions. In financial economies literature, these findings have been considered as a violation of market efficiency.
The main objective of this study is to determine market reactions around the day of insider trading and the day of announcements on Indian stock market. We are curious to perform our analysis on Indian data because a major chunk of studies on insider trading are concentrated on the U.S data. Therefore, the analysis of India insider trading data provides an independent outcome to compare with previous studies’ results. Besides, there are enough differences between the US and India market, which indicate that the results of these studies may not be robust in Asia or emerging markets. First difference, the ownership structure of emerging markets’ firms is more concentrated than developed markets’ firms (La Porta et al, 1999). For example, La Porta et al (1998) find that in the Indian firm, the top three shareholders contain around 40% of total shareholdings, whereas in the U.S. firm, the top three shareholders have around 20% of total shareholdings. Since the large shareholders of emerging countries’ firm bear additional risks that are associated with holding an undiversified portfolio (Demsetz, 1986). In addition to controlling rights, insider trading may provide an incentive to large shareholders to bear additional risks (Maug, 2002). Moreover, the large fraction of shares owned represents greater power to access non-public price sensitive information to the owner, and that should be reflected in stock trading activities (Demsetz, 1986). Second difference, an interesting aspect of this study is that we provide a detail comparison of both the US and Indian regulation on insider trading. There are marked differences between the two set of regulations with respect of the length of reporting within which insiders must report their trades to the firm, and the level of enforcements.
Third difference is the most influential that associate the information of insider trading with market efficiency. The common definition of market efficiency is that stock prices at any time ‘fully reflect’ all available information...

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