Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

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.


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

%d bloggers like this: