Abstract
This paper addresses the issue of how insider trading rules affect price formation in securities markets and suggests the application of information theory to market microstructure theory. We analyze a variant of the setting in [20] by simply introducing a more general criterion for informational efficiency borrowed from information theory — namely maximum information transmission. The analysis shows that both the insider's optimal trading strategy and the market price of the risky security depend on the insider trading restriction. Insider trading restrictions are reported to be detrimental to the liquidity of the securities market. We find that a unique insider trading rule exists which implements semi-strong form informational efficiency of the securities market. Alternative restrictions on insider trading give rise to either underreaction or overreaction in securities prices. Too strict insider trading rules are shown to account for excess volatility in securities prices. Contrary to common notion, the uninformed investors are shown to be hurt by too restrictive insider trading rules. We conclude that loose insider trading rules are preferred by the group of investors as a whole.
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callMore From: International Journal of Theoretical and Applied Finance
Disclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
