Insider Trading and Market Efficiency

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Journal of Finance and Accountancy

Insider t nsider trading and market efficiency: Do insiders buy low and sell h high? Stephanie Roddenberry Longwood University Dr. Frank Bacon Longwood University ABSTRACT The purpose of this study was to test the semi-strong form efficient market hypothesis strong using insider sale and purchase announcements and their effect on the risk adjusted rate of return of the firms’ stock price. Past studies using varying methodologies, including the risk adjusted model for event study methodology as used in this study, have found conflicting results have regarding the form of market efficiency upheld in the United States. By definition, a semisemi strong form efficient market would not allow any investor to earn an above normal risk adjusted return or to consistently outperform the market on the basis of publicly available information, such as an insider trade announcement. This study tests the speed of the market’s reaction to an insider trade announcement to determine if the reaction occurs either on or before the event, thus upholding the semi-strong form efficient market hypothesis. The analysis of two sample groups, strong sale and purchase insider trade announcements, was used to determine if and when the risk adjusted return of the stock price is significantly affected both on the announcement date and the during the defined event period. Results for insider sales support the semi-strong form efficient strong market hypothesis while the insider purchases analysis findings are mixed. The evidence is at . odds with the literature as insiders sales/purchases announcements delivered negative/positive insiders’ signals, respectively. Evidence of pre pre-announcement trading and an over-reaction effect were reaction also observed. For insider purchases and sales, the insiders follow a pattern of “buying low and selling high”. Keywords: insider trade, sale announcements, purchase announcements, semi strong efficient semi-strong

Insider Trading and Market Efficiency, Page 1

Journal of Finance and Accountancy INTRODUCTION Does insider trading information affect stock price? If so, how fast does the market react m to insider trading? It is reasonable to expect a significant market reaction to trading by insiders who possess non-public information about the firm. However, the efficient market hypothesis public suggests that legal insider trading with public information disclosure should not enable any investor to earn above normal returns by acting on this type of news. Market efficiency is a factor that is constantly tested, and past studies have produced evidence to support both scenarios. Studies provide evidence in favor of and against regulation tudies relating to market efficiency. Some argue that there should be no restrictions on insider trading, allowing for a more strong form efficient market where all information could be used. Others argue that regulations are necessary to uphold market integrity and to keep competition alive in the market. The laws implemented in the United States prohibit certain insider trading, making a strong form efficient market impossible. Therefore, the market should uphold the semi-strong impossible. semi form efficiency definition if tested in regards to insider trading, meaning no investor should be able to earn an above normal return on the basis of an insider trade announcement. Will a trading rule that mirrors insiders produce above normal returns? If so, then the abnormal return le to insiders suggests trading based on inside information, which is illegal in the United States even though the insiders are conducting “legal” insider trades. This research analyzes how inside trading sale and purchase announcements affect stock insider price up to 30 days before and after the announcement to further examine questions as to whether re uestions investors who act on publicly available insider trade announcements can beat the market. Likewise, this...
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