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Regulating Insider Trading when Investment Matters

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Author Info
Medrano, Luis Angel
Vives, Xavier

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Abstract

We analyse the effects of insider trading on real investment and welfare, and the consequences of different regulatory policies: a disclose-or-abstain rule, ‘fair’ disclosure, laissez-faire and forbidding insider trades based on ‘precise’ information. We perform the analysis in a model in which all traders are rational expected-utility maximizers and aware of their position in the market. We compare the equilibrium with insider trading with the equilibrium in the same market without insider trading in two scenarios: costly and costless information acquisition. We find that with costly information acquisition an abstain-or-disclose rule tends to be optimal while with free information acquisition laissez-faire is better. This suggests enforcing an abstain-or-disclose rule with a high standard of proof for inside information. This rule of thumb advocates a laissez policy both for selective disclosure and in high-tech industries. Our approach uncovers the pitfalls of welfare analysis in the noise trader model.

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Publisher Info
Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3292.

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Date of creation: Apr 2002
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Handle: RePEc:cpr:ceprdp:3292

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Related research
Keywords: disclose-or-abstain rule; hedging; insider trading selective disclosure; noise traders; real investment; speculation; welfare;

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Find related papers by JEL classification:
D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Diamond, Douglas W. & Verrecchia, Robert E., 1981. "Information aggregation in a noisy rational expectations economy," Journal of Financial Economics, Elsevier, vol. 9(3), pages 221-235, September. [Downloadable!] (restricted)
  2. Bray, Margaret, 1985. "Rational Expectations, Information and Asset Markets: An Introduction," Oxford Economic Papers, Oxford University Press, vol. 37(2), pages 161-95, June. [Downloadable!] (restricted)
  3. Bernhardt, Dan & Hughson, Eric, 2002. "Intraday trade in dealership markets," European Economic Review, Elsevier, vol. 46(9), pages 1697-1732, October. [Downloadable!] (restricted)
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  4. Danthine, Jean-Pierre & Moresi, Serge, 1993. "Volatility, information and noise trading," European Economic Review, Elsevier, vol. 37(5), pages 961-982, June. [Downloadable!] (restricted)
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  5. Manove, Michael, 1989. "The Harm from Insider Trading and Informed Speculation," The Quarterly Journal of Economics, MIT Press, vol. 104(4), pages 823-45, November. [Downloadable!] (restricted)
  6. Rahi, Rohit, 1996. "Adverse Selection and Security Design," Review of Economic Studies, Blackwell Publishing, vol. 63(2), pages 287-300, April. [Downloadable!] (restricted)
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  7. Damodaran, Aswath & Liu, Crocker H, 1993. "Insider Trading as a Signal of Private Information," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 6(1), pages 79-119. [Downloadable!] (restricted)
  8. Yosha Oved, 1995. "Information Disclosure Costs and the Choice of Financing Source," Journal of Financial Intermediation, Elsevier, vol. 4(1), pages 3-20, January. [Downloadable!] (restricted)
  9. Bhattacharya, Utpal & Spiegel, Matthew, 1991. "Insiders, Outsiders, and Market Breakdowns," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 4(2), pages 255-82. [Downloadable!] (restricted)
  10. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June. [Downloadable!] (restricted)
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  11. Khanna, Naveen & Slezak, Steve L & Bradley, Michael, 1994. "Insider Trading, Outside Search, and Resource Allocation: Why Firms and Society May Disagree on Insider Trading Restrictions," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 7(3), pages 575-608. [Downloadable!] (restricted)
  12. Holmstrom, Bengt & Tirole, Jean, 1993. "Market Liquidity and Performance Monitoring," Journal of Political Economy, University of Chicago Press, vol. 101(4), pages 678-709, August. [Downloadable!] (restricted)
  13. Sarkar Asani, 1994. "On the Equivalence of Noise Trader and Hedger Models in Market Microstructure," Journal of Financial Intermediation, Elsevier, vol. 3(2), pages 204-212, March. [Downloadable!] (restricted)
  14. Spiegel, Matthew & Subrahmanyam, Avanidhar, 1992. "Informed Speculation and Hedging in a Noncompetitive Securities Market," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 5(2), pages 307-29. [Downloadable!] (restricted)
  15. Kyle, Albert S, 1989. "Informed Speculation with Imperfect Competition," Review of Economic Studies, Blackwell Publishing, vol. 56(3), pages 317-55, July. [Downloadable!] (restricted)
  16. Bernhardt, Dan & Hollifield, Burton & Hughson, Eric, 1995. "Investment and Insider Trading," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 8(2), pages 501-43. [Downloadable!] (restricted)
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  17. Ausubel, Lawrence M, 1990. "Insider Trading in a Rational Expectations Economy," American Economic Review, American Economic Association, vol. 80(5), pages 1022-41, December. [Downloadable!] (restricted)
  18. Demange, G. & Laroque, G., 1992. "Private Information and the Design of Securities," DELTA Working Papers 92-22, DELTA (Ecole normale supérieure).
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  19. Demsetz, Harold, 1986. "Corporate Control, Insider Trading, and Rates of Return," American Economic Review, American Economic Association, vol. 76(2), pages 313-16, May. [Downloadable!] (restricted)
  20. Repullo, Rafael, 1999. "Some Remarks on Leland's Model of Insider Trading," Economica, London School of Economics and Political Science, vol. 66(263), pages 359-74, August. [Downloadable!] (restricted)
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  21. Leland, Hayne E, 1992. "Insider Trading: Should It Be Prohibited?," Journal of Political Economy, University of Chicago Press, vol. 100(4), pages 859-87, August. [Downloadable!] (restricted)
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Leonard J. Mirman & Marc Santugini, 2008. "A Financial Model of the Firm: Risk and Portfolio Selection," Cahiers de recherche 08-05, HEC Montréal, Institut d'économie appliquée, revised Sep 2009. [Downloadable!]
  2. Foucault, Thierry & Cespa, Giovanni, 2008. "Insiders-outsiders, transparency and the value of the ticker," Les Cahiers de Recherche 892, HEC Paris. [Downloadable!]
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  3. Giovanni Cespa, 2007. "Information Sales and Insider Trading with Long-lived Information," CSEF Working Papers 174, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy. [Downloadable!]
  4. Andrea Buffa & Giovanna Nicodano, 2006. "Should Insider Trading be Prohibited when Share Repurchases are Allowed?," Carlo Alberto Notebooks 16, Collegio Carlo Alberto. [Downloadable!]
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