Academic Research

Academic Studies related to Insider Trading

Several academic studies have been done over the years exploring the outperformance of insider trades and specifically insider buying. These studies have analyzed data over several decades and have shown that insider buying tends to outperform the overall market by 6% to 10.2% per year depending on which academic study and time period you look at.

According to the Wharton study “Estimating the Returns to Insider Trading” that looked at a comprehensive sample of insider transactions over 22 years from 1975-1996, about one-quarter of these abnormal returns accrue within the first five days after the trade and one-half accrues within the first month. You can read this research paper along with several other related papers below.

1. Title: Estimating the Returns to Insider Trading

Authors: Leslie A. Jeng, Andrew Metrick, Richard Zeckhauser

Universities: Leslie A. Jeng (Boston University School of Management)

Andrew Metrick (The Wharton School, University of Pennsylvania and NBER)

Richard Zeckhauser (John F. Kennedy School of Government, Harvard University and NBER)

Year of Publication: July, 1999

Abstract: This paper estimates the returns to insiders when they trade their company’s stock.

We first construct a rolling “purchase portfolio” that holds all shares purchased by insiders for a six-month period and an analogous “sale portfolio” that holds all shares

sold by insiders for six months. The six-month horizon is chosen to coincide with the “short-swing” rule of the Securities and Exchange Act of 1934; a rule that prohibits profit-taking by insiders for offsetting trades within six months. We then employ performance-evaluation methods to analyze the returns to the purchase and sale portfolios. This approach yields a proxy for the value-weighted returns to insider transactions beginning on the day after their execution and avoids the statistical difficulties that plague event studies on long-horizon returns.

Our methods are designed to estimate the returns earned by insiders themselves and thereby differ from the previous insider-trading literature, which focuses on the “informativeness” of insider trades for other investors. Using a comprehensive sample of reported insider transactions from 1975-1996, we find that the purchase portfolio earns abnormal returns of more than 50 basis points per month. About one-quarter of these abnormal returns accrue within the first five days after the initial transaction, and one-half accrue within the first month. The sale portfolio does not earn abnormal returns. Our portfolio-based approach also allows for straightforward decompositions of performance by various characteristics; we find that the abnormal returns to insider trades in small firms are not significantly different from those in large firms, and that top executives do not earn higher abnormal returns than do other insiders.

2. Title: Insiders and Market Efficiency

Author: Joseph E. Finnerty

University: Graduate School of Business Administration, The University of Michigan

Year of Publication: 1974

Abstract: The strong-form of the efficient market hypothesis is concerned with whether all available public and private information is fully reflected in a security’s market price. In terms of market participants, the strong-form states that no individual has higher expected trading profits than others just because he has monopolistic access to information. A test of the strong-form is to determine whether insiders earn better-than-average profits from their market transactions. To ascertain if the market is truly effective will involve determining how well insiders fare relative to the market in general.

3. Title: Special Information and Insider Trading

Author: Jeffrey F. Jaffe

University: The University of Chicago

Year of Publication: 1974

Abstract: Trading by corporate officers, directors, and large stockholders, who are commonly called insiders, commands widespread attention in the financial community. Academicians are interested in the amount of special information insiders possess, as well as in the profit they earn from such knowledge. The average investor seeks out useful information in the Official Summary of Insider Trading, the monthly report listing the transactions of corporate officials

4. Title: Are Insiders’ trades informative?

Authors: Josef Lakonishok and Lee Inmoo

University: Josef Lakonishok (University of Illinois at Urbana-Champaign; National Bureau of Economic Research (NBER)

Lee Inmoo (Dimensional Fund Advisors)

Year of Publication: 1998

Abstract: We document insider trading activities of all companies listed on the NYSE, Amex, and Nasdaq exchanges during the 1975-1995 period. Insider trading is common, and in more than half the sample firms, there is at least some insider activity in a given year. In general, very little market movement is observed when insiders trade and when they report their trades to the SEC. Insiders in aggregate are contrarian investors. However, they predict market movements better than simple contrarian strategies. Insiders also seem to be able to predict cross-sectional stock returns. The result, however, is driven by insider’s ability to predict returns in smaller firms. In addition, insider purchases are more informative than insider sales.

5. Title: Predictive and Statistical properties of Insider Trading

Authors:  James H. Lorie and Victor Niederhoffer

University: The University of Chicago

Year of Publication: 1968

Abstract: “Insiders” are officers, directors, and owners of ten per cent or more of the common stock of the companies listed on the New York and Ameri-can Stock Exchanges. The Securities and Exchange Commission (the SEC) requires that insiders keep the Commission informed regarding transactions in the common stock and convertible securities of the respective companies. The interest of the SEC in trading by insiders stems in part from the belief that insiders should not exploit their special opportunities to know about developments in their companies for personal profit through short-term trading. Further, the Commission feels that information on trading by insiders should be fully disclosed to the investing public because of light which such trading might cast upon the company’s future prospects.

6. Title: Market Efficiency and Insider Trading: New Evidence

Authors: Michael S Rozeff and Mir A Zaman

University: Michael S Rozeff (SUNY at Buffalo – Department of Financial & Managerial Economics)

Mir A Zaman (University of Northern Iowa – Department of Finance)

Year of Publication: 1988

Abstract: It is not surprising that corporate insiders earn profits from trading their stocks, but it is surprising that outsiders can earn abnormal returns by mimicking the insider trades using publically available information. We suggest that these anomalous returns are explained by the size and price/earnings ratio effects. Controlling for these factors reduces outsider profits by one-half. The additional assumption of 2 percent transactions costs makes outsider profits zero or negative. Measured insider profits are also greatly reduced by controlling for size and price/earnings effects. Insider profits are a modest 3 percent per annum after deducting a 2 perecnt transactions costs fee.

7. Title: Why does aggregate insider trading predict future stock returns?

Author: H Nejat Seyhun

University: The University of Michigan

Year of Publication: 1992

Abstract: This paper documents that, for the period from 1975 to 1989, the aggregate net number of open market purchases and sales by corporate insiders in their own firms predicts up to 60 percent of the variation in one-year-ahead aggregate stock returns. This study also examines whether the ability of aggregate insider trading to predict future stock returns can be attributed to changes in business conditions or movements away from fundamentals. Evidence suggests that both explanations contribute to the predictive ability of aggregate insider trading.