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Insider Trading, Investment, and Liquidity: A Welfare Analysis

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  • Sudipto Bhattacharya

Abstract

We compare equilibrium trading outcomes with and without participation by an informed insider, assuming inflexible ex ante aggregate investment choices by agents. Noise trading arises from aggregate uncertainty regarding other agents' intertemporal consumption preferences. The welfare levels of outsiders can thus be ascertained. The allocations without insider trading are not ex ante Pareto efficient, because our model differs from standard ones with negative exponential utility functions and normal returns. We characterize the circumstances under which the revelation of payoff-relevant information via prices-arising from insider trading-benefits outsiders with stochastic liquidity needs, by improving risk-sharing among them. Copyright The American Finance Association 2001.

Suggested Citation

  • Sudipto Bhattacharya, 2001. "Insider Trading, Investment, and Liquidity: A Welfare Analysis," Journal of Finance, American Finance Association, vol. 56(3), pages 1141-1156, June.
  • Handle: RePEc:bla:jfinan:v:56:y:2001:i:3:p:1141-1156
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    References listed on IDEAS

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    Cited by:

    1. Pei Peter Lung & Pisun Xu, 2014. "Tipping and Option Trading," Financial Management, Financial Management Association International, vol. 43(3), pages 671-701, September.
    2. Giovanni Cespa, 2007. "Information Sales and Insider Trading with Long-lived Information," CSEF Working Papers 174, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    3. Arnoud W. A. Boot & Radhakrishnan Gopalan & Anjan V. Thakor, 2008. "Market Liquidity, Investor Participation, and Managerial Autonomy: Why Do Firms Go Private?," Journal of Finance, American Finance Association, vol. 63(4), pages 2013-2059, August.
    4. Giovanni Cespa, 2008. "Information Sales and Insider Trading with Long-Lived Information," Journal of Finance, American Finance Association, vol. 63(2), pages 639-672, April.
    5. Yuri Pettinicchi, 2012. "Financial Literacy, Information Acquisition and Asset Pricing Implications," Working Papers 2012_03, Department of Economics, University of Venice "Ca' Foscari".
    6. Juan Jose Cruces & Enrique L. Kawamura, 2005. "Insider Trading and Corporate Governance in Latin America: A Sequential Trade Model Approach," Working Papers 86, Universidad de San Andres, Departamento de Economia, revised Dec 2005.
    7. Andrea Marcello Buffa, 2004. "Strategic Insider Trading with Imperfect Information: A Trading Volume Analysis," Rivista di Politica Economica, SIPI Spa, vol. 94(6), pages 101-143, November-.
    8. Andrea M. Buffa & Giovanna Nicodano, 2008. "Should Insider Trading be Prohibited when Share Repurchases are Allowed?," Review of Finance, European Finance Association, vol. 12(4), pages 735-765.
    9. Liang, Woan-lih & Lin, Hsiou-wei W. & Syu, Yir-Jung, 2010. "Precision of Investor Information and Financial Disclosure," International Review of Economics & Finance, Elsevier, vol. 19(4), pages 627-632, October.
    10. Maug, Ernst, 2002. "Insider trading legislation and corporate governance," European Economic Review, Elsevier, vol. 46(9), pages 1569-1597, October.
    11. Giovanni Cespa, 2007. "Information Sales and Insider Trading with Long-lived Information," Working Papers 613, Queen Mary University of London, School of Economics and Finance.
    12. Athanasakou, Vasiliki & Simpson, Ana, 2016. "Investor attention to rounding as a salient forecast feature," International Journal of Forecasting, Elsevier, vol. 32(4), pages 1212-1233.
    13. Liu, Dehong & Lung, Pei Peter & Lallemand, Justin, 2015. "Anticipation of takeovers in stock and options markets," International Review of Economics & Finance, Elsevier, vol. 39(C), pages 19-35.
    14. Fabio C. Bagliano & Carlo A. Favero & Giovanna Nicodano, 2011. "Insider Trading, Traded Volume and Returns," Working papers 26, Former Department of Economics and Public Finance "G. Prato", University of Torino.
    15. Chi-Wen Lee & Zemin Lu, 2008. "Trading on inside information when there may be tippees," Review of Quantitative Finance and Accounting, Springer, vol. 31(3), pages 241-260, October.

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