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Regulating Insider Trading When Investment Matters

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  • Luis Angel Medran
  • Xavier Vives

Abstract

We provide a general framework for analyzing the effects of insider trading on real investment and welfare as well as the consequences of different regulatory policies in a model where all traders are rational expected-utility maximizers and aware of their position in the market. We find that: with costly information acquisition, an "abstain-or-disclose" rule tends to be optimal; 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. Our approach also uncovers the pitfalls of welfare analysis in the noise-trader model. JEL classification: D82, G12, G14.

Suggested Citation

  • Luis Angel Medran & Xavier Vives, 2004. "Regulating Insider Trading When Investment Matters," Review of Finance, European Finance Association, vol. 8(2), pages 199-277.
    • Handle: RePEc:oup:revfin:v:8:y:2004:i:2:p:199-277.
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    Cited by:

    1. Mirman, Leonard J. & Santugini, Marc, 2013. "Firms, shareholders, and financial markets," The Quarterly Review of Economics and Finance, Elsevier, vol. 53(2), pages 152-164.
    2. Foucault, Thierry & Cespa, Giovanni, 2008. "Insiders-outsiders, transparency and the value of the ticker," HEC Research Papers Series 892, HEC Paris.
    3. Kurlat, Pablo & Veldkamp, Laura, 2015. "Should we regulate financial information?," Journal of Economic Theory, Elsevier, vol. 158(PB), pages 697-720.
    4. Krebs, Tom, 2005. "Fundamentals, information, and international capital flows: A welfare analysis," European Economic Review, Elsevier, vol. 49(3), pages 579-598, April.
    5. Nina Boyarchenko & David O. Lucca & Laura Veldkamp, 2015. "Taking orders and taking notes: dealer information sharing in financial markets," Staff Reports 726, Federal Reserve Bank of New York.
    6. Foucault, Thierry & Cespa, Giovanni, 2008. "Insiders-outsiders, transparency and the value of the ticker," HEC Research Papers Series 892, HEC Paris.
    7. Xavier Vives, 2014. "Strategic Complementarity, Fragility, and Regulation," The Review of Financial Studies, Society for Financial Studies, vol. 27(12), pages 3547-3592.
    8. Dieler, T., 2014. "Essays on asset trading," Other publications TiSEM ea0c811e-e335-402f-a3e2-8, Tilburg University, School of Economics and Management.
    9. Giovanni Cespa & Xavier Vives, 2012. "Dynamic Trading and Asset Prices: Keynes vs. Hayek," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 79(2), pages 539-580.
    10. Manzano, Carolina & Vives, Xavier, 2011. "Public and private learning from prices, strategic substitutability and complementarity, and equilibrium multiplicity," Journal of Mathematical Economics, Elsevier, vol. 47(3), pages 346-369.
    11. Giovanni Cespa, 2008. "Information Sales and Insider Trading with Long‐Lived Information," Journal of Finance, American Finance Association, vol. 63(2), pages 639-672, April.
    12. Vahe Lskavyan, 2015. "Insider regulation and the incentive to invest as an insider," Economics of Governance, Springer, vol. 16(3), pages 207-227, August.
    13. Bernhardt, Dan & Taub, Bart, 2010. "How and when is dual trading irrelevant?," Journal of Financial Markets, Elsevier, vol. 13(2), pages 295-320, May.
    14. Giovanni Cespa, 2008. "Information Sales and Insider Trading with Long‐Lived Information," Journal of Finance, American Finance Association, vol. 63(2), pages 639-672, April.
    15. David Russ, 2020. "Multidimensional Noise and Non-Fundamental Information Diversity," Working Papers 201, Bavarian Graduate Program in Economics (BGPE).
    16. Juan Jose Cruces & Enrique L. Kawamura, 2005. "Insider Trading and Corporate Governance in Latin America: A Sequential Trade Model Approach," Working Papers 86, Universidad de San Andres, Departamento de Economia, revised Dec 2005.
    17. Andrea M. Buffa & Giovanna Nicodano, 2008. "Should Insider Trading be Prohibited when Share Repurchases are Allowed?," Review of Finance, European Finance Association, vol. 12(4), pages 735-765.
    18. Nina Boyarchenko & David O. Lucca & Laura Veldkamp, 2016. "Taking Orders and Taking Notes: Dealer Information Sharing in Treasury Markets," NBER Working Papers 22461, National Bureau of Economic Research, Inc.
    19. Lenkey, Stephen L., 2017. "Insider trading and the short-swing profit rule," Journal of Economic Theory, Elsevier, vol. 169(C), pages 517-545.
    20. Maug, Ernst, 2002. "Insider trading legislation and corporate governance," European Economic Review, Elsevier, vol. 46(9), pages 1569-1597, October.
    21. Pavan, Alessandro & Vives, Xavier, 2015. "Information, Coordination, and Market Frictions: An Introduction," Journal of Economic Theory, Elsevier, vol. 158(PB), pages 407-426.
    22. Detemple, Jerome & Rindisbacher, Marcel & Robertson, Scott, 2022. "Dynamic noisy rational expectations equilibrium with insider information: Welfare and regulation," Journal of Economic Dynamics and Control, Elsevier, vol. 141(C).
    23. Russ, David, 2022. "Multidimensional noise and non-fundamental information diversity," The North American Journal of Economics and Finance, Elsevier, vol. 59(C).
    24. Winter, Christoph, 2018. "The Impact of Heterogeneous Signals on Stock Price Predictability in a Rational Expectations Model," Working papers 2018/21, Faculty of Business and Economics - University of Basel.

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    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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