Regulating Insider Trading when Investment Matters
AbstractWe analyse the effects of insider trading on real investment and welfare, and the consequences of different regulatory policies: a disclose-or-abstain rule, ‘fair’ disclosure, laissez-faire and forbidding insider trades based on ‘precise’ information. We perform the analysis in a model in which all traders are rational expected-utility maximizers and aware of their position in the market. We compare the equilibrium with insider trading with the equilibrium in the same market without insider trading in two scenarios: costly and costless information acquisition. We find that with costly information acquisition an abstain-or-disclose rule tends to be optimal while with free information acquisition laissez-faire is better. This suggests enforcing an abstain-or-disclose rule with a high standard of proof for inside information. This rule of thumb advocates a laissez policy both for selective disclosure and in high-tech industries. Our approach uncovers the pitfalls of welfare analysis in the noise trader model.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3292.
Date of creation: Apr 2002
Date of revision:
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Postal: Centre for Economic Policy Research, 77 Bastwick Street, London EC1V 3PZ.
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Other versions of this item:
- Luis Angel Medrano & Xavier Vives, 2004. "Regulating Insider Trading When Investment Matters," Review of Finance, Springer, vol. 8(2), pages 199-277.
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
This paper has been announced in the following NEP Reports:
- NEP-ALL-2003-03-14 (All new papers)
- NEP-CFN-2003-03-14 (Corporate Finance)
- NEP-FMK-2003-03-14 (Financial Markets)
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