Shadow Trading and Macroeconomic Risk

39 Pages Posted: 5 Jan 2021 Last revised: 17 Jan 2023

Date Written: January 17, 2023

Abstract

“Shadow trading” occurs when a corporate insider uses sensitive inside information pertaining to her own firm to buy or sell shares of other companies whose stock price movements can be predicted given the information. Because these transactions are highly profitable but not systematically regulated, they are a widespread phenomenon among corporate insiders. Unlike classical insider trading, shadow trading by a corporation’s insiders does not result in a direct harm to the corporation’s own shareholders, and to some extent, shareholders may even benefit from such transactions. In this Article, we argue nevertheless that shadow trading poses three issues: (i) it can create a moral hazard problem for corporate insiders, which can lead them to engage in excessive corporate risk-taking and to even invest in negative-expected-value projects; (ii) it can increase the level of macroeconomic risk to which the economy is exposed; and (iii) it can exacerbate the severity of economic crises. Our analysis thus offers novel rationales for regulating shadow trades. This Article concludes by suggesting a menu of possible policy reforms that can address the problems created by shadow trading.

Keywords: insider trading; shadow trading; macroeconomic risk; network theory; systematically important financial institutions; risk-taking; aggregate fluctuations; Rule 10b-5; securities regulation; misappropriation theory

JEL Classification: D85, E02, E32, K2, K22, L14

Suggested Citation

Lee, Yoon-Ho Alex and Romano, Alessandro, Shadow Trading and Macroeconomic Risk (January 17, 2023). Harvard Business Law Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3731719 or http://dx.doi.org/10.2139/ssrn.3731719

Yoon-Ho Alex Lee

Northwestern Pritzker School of Law ( email )

375 E. Chicago Ave
Chicago, IL 60611
United States
(312) 503-2565 (Phone)

Alessandro Romano (Contact Author)

Bocconi University - Department of Law ( email )

Via Roentgen, 1
Milan, Milan 20136
Italy

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