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Investment and Insider Trading

Bernhardt, Dan and Hollifield, Burton and Hughson, Eric (1993) Investment and Insider Trading. Social Science Working Paper, 830. California Institute of Technology , Pasadena, CA. (Unpublished) https://resolver.caltech.edu/CaltechAUTHORS:20170825-161136189

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Abstract

Within a dynamic environment, this paper introduces an inside trader to an economy where rational, but uninformed, traders choose between investment projects with different levels of insider trading. When inside information has little value in future investment decisions, insider trading distorts investment towards assets with less private information, imposing net welfare costs on the economy. When an insider's private information is valuable in making future investment decisions, the net social benefit of inside trading can be positive; the resulting increases in investment efficiency due to more informative prices is enough to compensate for the distortion induced by the inside trader. When insiders receive private information more than once, insiders may trade to reveal their private information at the beginning of their relationship with the firm. This has two effects; i) more information is revealed in equilibrium and ii) there is less chance than an uninformed agent will have to trade with the insider. Both these effects reduce the investment inefficiencies associated with insider trading. As a consequence, uninformed liquidity traders prefer to trade in a market with a long-term insider. This improvement in investment efficiency, leads to a Pareto improvement - both the uninformed traders and the insider are made better off if the insider receives information more than once.


Item Type:Report or Paper (Working Paper)
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http://resolver.caltech.edu/CaltechAUTHORS:20171108-135327944Related ItemPublished Version
Additional Information:The first two authors are grateful to the SSHRC for financial support. We would also like to thank the Vancouver Stock Exchange for financial support. We wish to thank Jonathan Berk, Bob Dammoni Merwan Engineer, Paul Fischer, Rick Greeni Praveen Kumar, Huw Lloyd-Ellis, Ted Neave) Gregor Smith, Chester Spatt, Raman Uppal, participants at the 1992 Western Finance Association Meetings, the 1991 Canadian Economic Theory conference, the 1991 Pacific Northwest. Finance conference and finance seminars at Carnegie Mellon University, MIT and UBC for useful comments. The usual disclaimer applies. Published as Bernhardt, Dan, Burton Hollifield, and Eric Hughson. "Investment and insider trading." The Review of Financial Studies 8, no. 2 (1995): 501-543.
Group:Social Science Working Papers
Funders:
Funding AgencyGrant Number
Social Sciences and Humanities Research Council (SSHRC)UNSPECIFIED
Vancouver Stock ExchangeUNSPECIFIED
Subject Keywords:Trade, Insider trading, Investors, Liquidity, Financial investments, Market equilibrium, Long term investments, Capital investments, Inside information, Economic capital
Series Name:Social Science Working Paper
Issue or Number:830
Record Number:CaltechAUTHORS:20170825-161136189
Persistent URL:https://resolver.caltech.edu/CaltechAUTHORS:20170825-161136189
Usage Policy:No commercial reproduction, distribution, display or performance rights in this work are provided.
ID Code:80821
Collection:CaltechAUTHORS
Deposited By: Jacquelyn Bussone
Deposited On:28 Aug 2017 20:44
Last Modified:03 Oct 2019 18:35

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