Hedge Funds are on the Ball When Insiders Trade

Abstract

This study examines the use of insider trading information by hedge funds. We find that hedge funds tend to trade in the same direction as insiders when insider trades are likely driven by information, while they do not respond to likely liquidity-driven insider trades. This finding is consistent with hedge funds deciphering profitable insider trading information. In contrast, mutual funds, pension funds, and other institutional investors (mostly banks and insurance companies) are more likely to trade in the opposite direction as insiders, acting as liquidity providers regardless of the insiders’ trading motives. Further, there is evidence that a hedge fund’s ability to exploit insider trading information helps improve its performance.

Keywords: Hedge funds, Insider trading