Shadow Trading

Abstract

We investigate the effects of inter-firm information transfers that occur prior to the release of private information. We find that prior to a given firm’s (“source firm”) release of relevant private information, business partners or competitors (“linked firms”) experience a 6.4%-19.2% increase in symptoms of informed trading activity, an activity we characterize as “shadow trading.” Each typical shadow trading event represents trading profits of up to approximately $678,000. Additional tests suggest that shadow trading is driven by trading or leaks from source firm employees and that shadow trading activity increases following increased scrutiny against conventional insider trading. Our study is relevant for legislators and regulators seeking to promote confidence in the integrity of capital markets.

Keywords: Business Partners; Informed Trading; Private Information; Supply Chain

JEL Classification: D4, G14, K22