Insider trading regulation and shorting constraints. Evaluating the joint effects of two market interventions.

Abstract

Modern capital markets are subject to many interventions and regulations, some of which curtail the implementation of specific trading strategies in a market. While we understand much of these regulations’ individual effects, the picture is less clear about their joint effects. This paper considers the interaction of two regulations, namely rules limiting shorting of assets and cash, and rules limiting insider trading. For these regulations, prior research shows spikes in short-selling activity around the revelation of insider information, which different studies trace to different causes. Among other results, we find that both allowing short positions and allowing informed trading causes informed traders to increase their market activity and causes mispricing and spreads to diminish. Nevertheless, we find no evidence for significant interaction effects between the two regulations.

Keywords: Insider trading, short positions, regulation, asset market, asymmetric information, experiment

JEL Classification: C92, D82, G10, G12, G14, G40