Inside Insider Trading

Abstract

How do insider traders act on private information? Despite the breadth of the theoretical literature analyzing this issue, direct evidence of insiders’ behavior is scarce as private information sets and corresponding trades are almost never observable. We address this identification challenge by utilizing a unique hand-collected sample of insider trading cases prosecuted by the U.S. Securities Exchange Commission (SEC). We find evidence that insider traders strategically time when to trade after receiving tips about firm fundamentals. They also seek to minimize their price impact by splitting their trades, as in Kyle’s model, and manage their trades’ size according to prevailing liquidity conditions. The value and type of information, not only its sign, both play a crucial role in designing trading strategies. Individual characteristics, such as investing expertise and age, also play an essential role. By exploiting the adoption of the SEC Whistleblower Reward Program, we find evidence that insider traders (i) react to higher enforcement risk by waiting to trade and splitting their trades further, and (ii) concentrate on information of higher value. Thus, insider trading enforcement may hamper stock price informativeness.

Keywords: Private Information, Insider Trading, Trading Strategies, Liquidity, Asset Prices, Volume, Stock Markets, Option Markets, Volatility, SEC, Financial Crime

JEL Classification: G14, G18, G40, G41