Abstract
Liquidity traders perceive disclosures of insider trading as ambiguous pieces of information, as they may not be able to assess whether the trades are motivated by significant privileged information related to the true share value, or by other uninformative factors. This paper establishes an algorithm, based on Bayesian inference that represents the rational value of ambiguous information associated with the disclosure of insider trading when market participants subsequently anticipate material information that may or may not follow. We found that the theoretical value has a statistically significant predictive power for the actual market reaction to these disclosures. We find an overall one-day excess return is in the neighborhood of one percent (and higher for insiders who have a controlling position). However, the ex-post 30- and 90-day single-factor-CAR, are significantly higher, which conforms to the notion of ambiguity. The small difference between the actual market reaction and the theoretical derivation (0.9674% vs. 1.328%) does not necessarily imply that the market underestimates the value of this type of information, as it may be related to the period until the value of the information is nullified because no new confirming information follows the disclosure.
Highlights
Disclosure of insider trading, which has become mandatory in most of the security exchanges worldwide, sends an ambiguous signal to market makers and liquidity traders who attempt to assess the nature of this new information
We argue that the information content, associated with the disclosures of insider trading is ambiguous, and the expected immediate market reaction is very different, the longer-term reaction, given that material relevant information may or may not follow and confirms the fact that insiders traded on privileged information
The one-day excess return, AR1, represents the immediate market reaction to the disclosures of insider trading, given that liquidity traders are unable to assess whether or not these trades are motivated by privileged information regarding the true value of the firm's shares
Summary
Disclosure of insider trading, which has become mandatory in most of the security exchanges worldwide, sends an ambiguous signal to market makers and liquidity traders who attempt to assess the nature of this new information. Bolandnazar, Jackson, Jiang, and Mitts (2020) demonstrate that trading intensity and the pace at which prices incorporate information decrease with the expected delay until public release, but the relation between trading intensity and time elapsed varies with traders’ learning process It seems that the underlying assumption of the above studies is that insider trading is motivated by new privileged information regarding the overall value of the firm, while potential ambiguity has not been dealt with directly. Perhaps this is one reason (in addition to methodological issues that are discussed below) why the empirical results reported in the literature are not conclusive. We test whether other variables, such as market cap, EPS, and power of control, may explain the magnitude of market reaction to insider trading
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