A Supervisory Perspective on Insider Trading: Estimating the Value of the Information
CONSOB, Quaderni di Finanza n. 2000-45
32 Pages Posted: 3 Apr 2001
Date Written: November 16, 2000
The enforcement of the ban on insider trading requires an evaluation of the disgorgement, i.e. the capital gain of the insider trader who takes advantage of the exploitation of preferential information. An initial step forward on this topic has been taken by the SEC, the United States Securities and Exchange Commission, which has developed a quantitative procedure based on the event-study methodology. This paper develops an adaptation of this procedure for the Italian market and explains the limits of this methodology in the analysis of the insider-trading phenomenon. In particular, it emerges that the econometric approach cannot be applied to all insider-trading schemes. In fact, in order to work out statistically significant results, it relies on a series of assumptions such as the existence of a robust reference market index or the availability of long time series data. For this reason, a new procedure for computing the economic value of the information exploited by the insider, based on a probabilistic approach, has also been developed. This methodology overcomes the issues connected to the event-study procedure and can be applied by construction to all insider-trading schemes and not only to the simplest ones. In fact, the model parameters are defined by using the trading strategy of the single insider; thus, if insider trading takes place, the model is able to offer a disgorgement computation; hence, by hypotheses of its construction, it is able to detect the difference between insiders and followers. Both procedures have been adopted by CONSOB, the Italian Securities and Exchange Commission, and have been presented to the Tribunal of Milan.
Keywords: SEC, CONSOB, insider trading, disgorgement, event studies analysis, proxy variable, geometric Brownian motion, wiener process, abnormal return, cumulative abnormal return
JEL Classification: G14, C53, G18, D82, G28, K22
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