Strategic leakage of private information

Abstract

We present a model where an insider and multiple informed outsiders share some common information about a risky asset to analyze the insider’s incentive for voluntarily leaking information to the market maker. We find that the ex-ante uncertainty of the traded asset and the number of informed outsiders play a decisive role in the insider’s choice of information leakage. When trading an asset with low risk against very few informed outsiders, the insider never chooses to leak any information. However, if sufficient outsiders coexist in the market, strategically releasing a signal to the market maker helps the insider anticipate the price and consequently earn more profits. In this case, if the insider’s monopoly information advantage is large, the insider would choose to fully leak the shared information to the market maker. Our work shows that information leakage to the market maker is more efficient than the public disclosure of the shared private information as a way for the insider to profit from insider trading. The results also provide the theoretical explanation for the insider’s leaking information to the underwriter in seasoned equity offerings (SEOs).