How do illegal insider traders act on private information? We address this questionusing a unique sample of illegal insider traders convicted by the Securities ExchangeCommission (SEC). To shed light on the traders’ investment strategies, we analyze,theoretically and empirically, the tradeoff between the risk of information becomingpublic (information risk), and the risk of being subject to enforcement (legal risk).Using a regression model and various shocks to enforcement risk, we find that a sub-set of investors responds to this tradeoff by splitting their trades more and tradingless aggressively in the presence of greater legal risk and smaller information risk.At the same time, a large fraction of traders does not internalize such a tradeoff.The insiders manage their trades’ size according to prevailing liquidity conditions,volatility of returns, noise trading activity, and the precision of the signal. Individ-ual characteristics, such as investing expertise and age, also play an essential role.Insiders facing increasing legal risk concentrate more on information of higher value.Thus, insider trading enforcement could hamper stock price informativeness.
Kacperczyk, Marcin T. and Pagnotta, Emiliano, Becker Meets Kyle:
Inside Insider Trading (March 13, 2019). Available at SSRN: https://ssrn.com/abstract=3142006 or http://dx.doi.org/10.2139/ssrn.3142006
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