However, insider trading causes significant harm. However, some people, like Rajat Gupta who received a two-year sentence in June , receive lighter sentences for various reasons.
Many shareholders — and others simply contemplating getting involved in the market — are very likely to postpone future dealings with Wall Street out of new fears of being cheated;. As insider trading increases, law enforcement efforts to fight and control it are weakened due to lack of prosecutorial resources.
When this illegal behavior multiplies, some companies and individuals start feeling empowered to keep on coordinating insider trades because they come to believe their chances of being caught are very low. If such a deviation is detected, then it can be inferred that investors are mimicking insiders and that they believe insiders' transactions are based on non-public information.
To investigate the effect of insider trade on price, studies like Tavakoli et al. However, there is no study that uses daily closing stock price and event study method to analyze the effect of insider trading on price. It is essential to study the impact of insider trading on the daily stock price as daily stock price data is devoid of intraday data issues like intraday volatility movements for example, the volatility is high at the opening and closing of the trading day and microstructure noise.
Therefore, the daily closing stock price data are used to study the effect of insider trade on the stock price. Some studies connect market efficiency with abnormal values of stock characteristics Aktas et al. According to such studies, the abnormal value of stock characteristics proves that the market is not efficient. The event study method is undertaken to calculate the abnormal value of stock price, return and volume.
The mean model is used to calculate abnormal price, and the market model is used to calculate abnormal return. The method proposed by Ajinkya and Jain is used to calculate the abnormal volume.
The paper also studies the effect on stock characteristics after insider purchases and insider sales. The data for the study include most liquid Indian firms listed on the Bombay Stock Exchange.
Tavakoli et al. Following such studies, the paper examines the effect of transactions of different types of insiders on the stock characteristics. The study also analyses the relationship between abnormal return and abnormal volume. The findings indicate that insider trades significantly affect the stock characteristics price, return and volume.
This finding is true for both buy and sell transactions. The results also indicate that insider trades of directors and executives, promoters [1] and majority shareholders affect the stock price and volume.
However, the transactions of most of these insiders are found to have no effect on return. The results also indicate that there is no relationship between abnormal return and abnormal volume. This study contributes to the current literature in the following ways. The study suggests a method to calculate the abnormal price.
This helps to understand how price reacts after an insider trade and also contributes toward the market efficiency literature. The study investigates the relationship between abnormal return and abnormal volume, after an insider trade. The study is also the first to investigate the effect of insider trades of different category of insiders on price, return and volume. This will help to detect trade of which category of insiders is mostly mimicked by outside investors and whose trade is generating higher abnormal return and price.
This insight can be used by investors. The study also investigates the effect of buy and sell transactions of different category of insiders. This will further help in investment decisions as sell transactions are known to be based on liquidity concerns. The paper is organized as follows. The next section presents an overview of the literature. Section 3 discusses the method, and Section 4 the data and results. The conclusion is provided in Section 5. This study investigates the effect of insider trading on the stock markets by assessing its impact on stock characteristics like price, return and volume.
The findings from extant literature corresponding to each stock characteristic are reviewed below. Most of the studies use the abnormal return to study the effect of insider trading on price Chakravarty and McConnell, ; Inci et al.
There has been scant focus on the price effect of insider trading. Very few studies use daily price data to examine the effect of legal insider trading on stock price.
Leland suggests that when insider trading is permitted, stock price is higher on an average. Aktas et al. Many studies suggest that return is affected by insider trades Pettit and Venkatesh, ; Chang and Suk, ; Gurgul and Majdosz, ; Degryse et al. Most studies indicate that insider trades result in higher abnormal return for the insiders Jeng et al.
Studies like Jeng et al. However, studies like Cheuk et al. As insider trades lead to positive abnormal return and have predictive powers, it is expected that these trades act as a signal to uninformed investors.
Wisniewski and Bohl , Gurgul and Majdosz , Firth et al. Thus, most studies assert that insider trades result in abnormal return for insiders and can be mimicked by outsiders to earn abnormal return. Various studies have reported that insider trading results in an increase in the volume of the market Buffa, ; Chang and Suk, ; Bruce et al.
As a result, they try to mimic the insiders' trades. Numerous studies have confirmed the hypothesis and have suggested that outsiders attempt to mimic insider trades, thereby increasing trading volume Firth et al. However, Aktas et al. Gurgul and Majdosz suggest that only insider purchases affect the volume, and this effect can be seen three days prior to the announcement.
Most of the literature mentioned above are not studied in India or countries with similar institutional setting. The institutional setting in India differs a lot from the US or any other developed nation. The significant differences are — concentrated ownership, lax implementation of regulations and slow information dissemination. The distinct institutional setting in India does present an opportunity to investigate if insiders benefit abnormally from their trades. Studies suggest that insider trading affects either price, return or volume, but no study examines the effect of insider trading on all the three stock characteristics.
Keeping in view the above mentioned research gap, the following hypothesis is proposed: H1. Insider trading affects stock characteristics — price, return and volume. Most of the studies analyze the impact of trading of only one type of insider on one of the stock characteristics Degryse et al. For example, Pettit and Venkatesh and Degryse et al.
None of the studies analyze the impact of trades of all types of insiders on all the stock characteristics. The following hypothesis is proposed to address the research gap: H2. Insider trades of different types of insiders affect the stock characteristics. A number of studies Hiemstra and Jones, ; Chen et al. Bajo has studied, in a minimal way, the relationship between abnormal volume and abnormal return by finding out the amount of abnormal return in three different abnormal volume cut-offs.
To address this research gap, the following hypothesis is proposed: H3. Abnormal return affects abnormal volume and vice-versa. The short-run event study method Brown and Warner, and its variants are adopted for addressing the hypotheses. The method used for each stock characteristic is explained below. The event study method requires the determination of two periods — an estimation window [ t 1 , t 2 ] and an event window [ T 1 , T 2 ].
In most of the studies related to investigating the effects of insider trading on return for example, Wisniewski and Bohl, ; Cheuk et al. However, in studies like Eyssell and Arshadi and Bajo , which study the effects of insider trading on volume, it is observed that the estimation period is much shorter Eyssell and Arshadi, — days and Bajo, —66 days.
As the study involves investigating the effects of insider trading on return, volume and price, the estimation period is kept short, i. Most of the studies have tried to study the impact of insider trading on stock price by using abnormal return like Dardas, ; Inci et al.
In this study, a distinct method is used to estimate the impact of insider trading on the stock price. Ajinkya and Jain suggest two models to calculate the abnormal volume using the event study method — the mean and market models. P j , i is the closing price on i th day of j th stock. The difference between the actual stock price and the expected stock price gives the abnormal stock price, i.
AAP i average abnormal price at time i. The result' s statistical significance is validated using the t -statistic which is calculated by using the crude dependence test [2] proposed by Brown and Warner Most of the studies use the event study method proposed by Brown and Warner to investigate if insiders earn an abnormal return Pettit and Venkatesh, ; Chang and Suk, ; Gurgul and Majdosz, ; Degryse et al.
While some studies like Eckbo and Smith and Jeng et al. The values of R j,i and R m,i during the estimation period are calculated. These parameters are applied to get the expected return values during the event period. Studies like Chang and Suk have used the model suggested by Ajinkya and Jain to calculate the abnormal volume. However, studies like Bajo have used the model suggested by Jarrell and Poulsen to calculate the normalized abnormal volume. One of the differences between Jarrell and Poulsen and Ajinkya and Jain model is that Ajinkya and Jain model uses the market volume to calculate the abnormal return.
In this study, the market model suggested by Ajinkya and Jain is implemented as the market volume is an essential factor in the study, and it should be taken into consideration while estimating the abnormal volume. Following is the model which is applied to calculate the abnormal volume:. As raw volume is not normally distributed, the log-transformed volume is used for the event study. Ajinkya and Jain suggest that volume and residuals of the market model for volume are significantly auto-correlated.
To remove the autocorrelation and estimate the intercept and slope coefficient correctly, Ajinkya and Jain suggest using estimated generalized least squares EGLS model to estimate Eqn 11 while imposing AR 1 structure on the residuals. A simultaneous equation modeling between abnormal return and abnormal volume is used to study if either of them affects the other.
Abnormal price is not used as there is no literature support for variables that might affect abnormal price. Cumulative abnormal return CAR is proxied for abnormal return, and cumulative abnormal volume CAV is proxied for abnormal volume. To conduct simultaneous equation modeling with cross-sectional data, Brooks and Hill et al.
Wisniewshki and Bohl , Cheuk et al. Gurgul and Majdosz and Wisniewshki and Bohl have used the type of insider transaction buy or sell as an independent variable. Natural logarithm of the volume of shares transacted, dummy for promoter's trade and dummy for director and executive's trade are used as the instrumental variables. Core et al. Park et al.
Similarly, Dardas has used the type of insider as an independent variable against CAV. The natural logarithm of market capitalization and price-to-book ratio are the instrumental variables in this regression.
For each of the TSLS regressions, the Stock and Yogo test is used to confirm if the instrumental variables are strong. The Hansen—Sargan overidentification test examines the validity of the instrumental variables. The equations for the model are as follows:.
This study' s time period is April, to March, , mainly because of the availability of insider trading data in India. Insider trading data beyond April, has not been used in this study as there was a significant change in insider trading regulations in April, We consider only market transactions by insiders for the study.
Insider trading data is collected from BSE [5] Website. BSE publishes all insider trade information like date and nature of insider trade, name of the insider, number of shares transacted, regulation followed for the transaction, mode of insider trade, number of shares held by the insider and the day the trade is reported to the exchange.
To ensure availability of data related to stock price and volume, only those firms included in BSE [6] as on 5th June, are considered. The stock price and volume data are collected from the Bloomberg Terminal.
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Measure content performance. Develop and improve products. List of Partners vendors. Your Money. Personal Finance. Your Practice. Popular Courses. Key Takeaways Insider trading refers to the purchase or sale of securities by someone with information that is material and not in the public realm. Critics of insider trading laws claim it should be legal because it provides useful information to markets and the laws against it can harm innocent people, while the offense itself causes little damage to others.
The main argument against insider trading is that it is unfair and discourages ordinary people from participating in markets, making it more difficult for companies to raise capital.
Insider trading based on material nonpublic information is illegal. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace. Related Articles. Partner Links. Insider trading is using material nonpublic information to trade stocks and is illegal unless that information is public or not material.
The Insider Trading Sanctions Act of is a piece of federal legislation that allows the SEC to seek civil penalties for insider trading. Material Nonpublic Information Definition Material nonpublic information is data relating to a company that has not been made public but could have an impact on its share price. What Is Insider Information? Insider information is a fact that can be of financial advantage if acted upon before it is generally known to shareholders.
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