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Regulating Insider Trading When Investment Matters

  • Luis Angel Medrano
  • Xavier Vives

We provide a general framework for analyzing the effects of insider trading on real investment and welfare as well as the consequences of different regulatory policies in a model where all traders are rational expected-utility maximizers and aware of their position in the market. We find that: with costly information acquisition, an "abstain-or-disclose" rule tends to be optimal; 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. Our approach also uncovers the pitfalls of welfare analysis in the noise-trader model.

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Article provided by Springer in its journal European Finance Review.

Volume (Year): 8 (2004)
Issue (Month): 2 ()
Pages: 199-277

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Handle: RePEc:kap:eurfin:v:8:y:2004:i:2:p:199-277
Contact details of provider: Web page: http://springerlink.metapress.com/link.asp?id=111870

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  1. Holmstrom, Bengt & Tirole, Jean, 1993. "Market Liquidity and Performance Monitoring," Journal of Political Economy, University of Chicago Press, vol. 101(4), pages 678-709, August.
  2. Utpal Bhattacharya & Hazem Daouk, 2002. "The World Price of Insider Trading," Journal of Finance, American Finance Association, vol. 57(1), pages 75-108, 02.
  3. Dan Bernhardt & Eric Hughson, 1991. "Intraday Trade in Dealership Markets," Working Papers 841, Queen's University, Department of Economics.
  4. Jean-Pierre DANTHINE & Serge MORESI, 1990. "Volatility, Information, and Noise Trading," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 9015, Université de Lausanne, Faculté des HEC, DEEP.
  5. Demange Gabrielle & Laroque Guy, 1995. "Private Information and the Design of Securities," Journal of Economic Theory, Elsevier, vol. 65(1), pages 233-257, February.
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  8. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  9. Manove, Michael, 1989. "The Harm from Insider Trading and Informed Speculation," The Quarterly Journal of Economics, MIT Press, vol. 104(4), pages 823-45, November.
  10. Yosha Oved, 1995. "Information Disclosure Costs and the Choice of Financing Source," Journal of Financial Intermediation, Elsevier, vol. 4(1), pages 3-20, January.
  11. Bhattacharya, Utpal & Spiegel, Matthew, 1991. "Insiders, Outsiders, and Market Breakdowns," Review of Financial Studies, Society for Financial Studies, vol. 4(2), pages 255-82.
  12. Leland, Hayne E, 1992. "Insider Trading: Should It Be Prohibited?," Journal of Political Economy, University of Chicago Press, vol. 100(4), pages 859-87, August.
  13. Rohit Rahi, 1993. "Adverse selection and security design," Economics Working Papers 64, Department of Economics and Business, Universitat Pompeu Fabra, revised Feb 1994.
  14. Khanna, Naveen & Slezak, Steve L & Bradley, Michael, 1994. "Insider Trading, Outside Search, and Resource Allocation: Why Firms and Society May Disagree on Insider Trading Restrictions," Review of Financial Studies, Society for Financial Studies, vol. 7(3), pages 575-608.
  15. Kyle, Albert S, 1989. "Informed Speculation with Imperfect Competition," Review of Economic Studies, Wiley Blackwell, vol. 56(3), pages 317-55, July.
  16. Spiegel, Matthew & Subrahmanyam, Avanidhar, 1992. "Informed Speculation and Hedging in a Noncompetitive Securities Market," Review of Financial Studies, Society for Financial Studies, vol. 5(2), pages 307-29.
  17. Damodaran, Aswath & Liu, Crocker H, 1993. "Insider Trading as a Signal of Private Information," Review of Financial Studies, Society for Financial Studies, vol. 6(1), pages 79-119.
  18. Ausubel, Lawrence M, 1990. "Insider Trading in a Rational Expectations Economy," American Economic Review, American Economic Association, vol. 80(5), pages 1022-41, December.
  19. Bernhardt, Dan & Hollifield, Burton & Hughson, Eric, 1995. "Investment and Insider Trading," Review of Financial Studies, Society for Financial Studies, vol. 8(2), pages 501-43.
  20. Diamond, Douglas W. & Verrecchia, Robert E., 1981. "Information aggregation in a noisy rational expectations economy," Journal of Financial Economics, Elsevier, vol. 9(3), pages 221-235, September.
  21. Bray, Margaret, 1985. "Rational Expectations, Information and Asset Markets: An Introduction," Oxford Economic Papers, Oxford University Press, vol. 37(2), pages 161-95, June.
  22. Demsetz, Harold, 1986. "Corporate Control, Insider Trading, and Rates of Return," American Economic Review, American Economic Association, vol. 76(2), pages 313-16, May.
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