Insider Trading – Chasing Private Information Marcin T. Kacperczyk Imperial College London – Accounting, Finance, and Macroeconomics; National Bureau of Economic Research (NBER) Emiliano Pagnotta Imperial College Business School November 24, 2015 Abstract: Abstract Using a sample of 3,586 illegal insider trades documented by the SEC, we examine whether asset prices and volume reveal firm-specific private information to markets. We find that information embedded in equity markets is a weak signal of private information. In turn, information embedded in option markets offers a strong signal of informed trading. We show that volume is generally more informative about insider trading than are prices, and that the most robust metrics combine both option and stock volume. Further, we show that the impact of insider trades holds irrespective of whether insiders trade strategically or not. Finally, we document significant information spillovers from equity to option markets, but not vice versa. Overall, our results provide strong and novel guidance in the search for private information. Insider Trading – Chasing Private Information – Introduction Asymmetric information is ubiquitous in economics and finance (e.g., Akerlof, 1970; Grossman and Stiglitz, 1980). A large number of theories in asset pricing and corporate finance, ranging from intermediation to asset management and market efficiency, rely on the presence of privately informed investors. To test these theories one faces the challenge that information sets are almost never observable. In an attempt to identify private information, the literature has proposed a wide array of empirical proxies that are based on publicly available data.1 Such measures, however, may not reflect private information but a number of spurious factors. For example, changing levels of illiquidity may be due to a systematic liquidity component or uninformed demand pressure. Ultimately, the decision maker is never sure whether the signals she observes are informative or not. In this paper, we consider a novel setting–insider trading cases–in which we can directly evaluate the quality of market signals. Specifically, we hand-collect a comprehensive sample of insider trading investigations by the SEC documenting how certain individuals trade on secret material information. Our sample of legal cases involves a large number of trades in several hundred companies over the period 1995-2012. The advantage of using insider trading data is that we can observe the dynamics of market signals at times when private information is used and, therefore, we can assess their ability to identify private information. http://www.valuewalk.com/2015/12/ch...m_campaign=EMAIL_DAILY&utm_content=quick_link