How Much Does an Illegal Insider Trade?

Abstract

We develop a model of the choice of trade size by an illegal insider. The model recognises that insiders respond to both the expected gains and costs associated with their crime, and choose a trade size which maximises the expected utility of wealth associated with the trade. The model predicts that the size of an insider’s trade is a function of the value of their information, the expected penalty if detected and a number of variables related to the probability of detection which includes the structure of the market in which they trade, the number of days prior to an information announcement that they transact and their relationship to the corporation with which they trade. The model also recognises that besides being criminals, illegal insider traders are also investors, and therefore respond to the volatility of asset returns in the security for which they have non-public information. Using a unique dataset hand-collected from the litigation reports of the Securities and Exchange Commission and court cases we provide evidence consistent with the predictions of the model.

JEL Classification: G10