Prof. Jayanth R. Varma's Financial Markets Blog

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Prof. Jayanth R. Varma's Financial Markets Blog, A Blog on Financial Markets and Their Regulation

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Tue, 21 Mar 2006

Informed trading or insider trading

Regulators seem to have great difficulty in distinguishing between informed trading and insider trading.

A study published in the Occasional Paper Series of the Financial Services Authority of the UK demonstrates that there are large (and statistically significant) abnormal stock returns ahead of takeover announcements. This is clearly evidence of informed trading but not necessarily of insider trading. After all, there is a lot of informed speculation ahead of any bid. The authors try to finesse the problem with an inappropriate definition of insider trading:

Throughout this paper the term “insider trading” is used to mean acting or causing others to act on material non-public information which could affect the value of an investment. This term is not a legal one but is intended to include the UK legal offences of insider dealing and misuse of information.

The financial press has been quoting the study extensively as evidence of insider trading. John Gapper writes in the Financial Times “Last week, [the FSA] said there were signs of insider trading before 29 per cent of UK mergers and acquisitions announcements.” Steve Goldstein wrote an article in headlined “Insider trading rife in U.K. M&A: study ”. The opening sentence of the article uses the phrase “insider trading” while the second paragraph uses the phrase “informed trading”.

This confusion is unfortunate. Informed trading is the life blood of financial markets and if the only way to stop insider trading is to shut down informed trading, then it is far better to live with insider trading.

Posted at 13:37 on Tue, 21 Mar 2006     View/Post Comments (0)     permanent link