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One study suggests insiders profited even from the global financial crisis;
another that the whole share-trading system is rigged.
INSIDER-TRADING prosecutions have netted plenty of small fry. But many grumble
that the big fish swim off unharmed. That nagging fear has some new academic
backing, from three studies. One argues that well-connected insiders profited
even from the financial crisis.* The others go further still, suggesting the
entire share-trading system is rigged.**
What is known about insider trading tends to come from prosecutions. But these
require fortuitous tip-offs and extensive, expensive investigations, involving
the examination of complex evidence from phone calls, e-mails or informants
wired with recorders. The resulting haze of numbers may befuddle a jury unless
they are leavened with a few spicy details exotic code words, say, or (even
better) suitcases filled with cash.
The papers make imaginative use of pattern analysis from data to find that
insider trading is probably pervasive. The approach reflects a new way of
analysing conduct in the financial markets. It also raises questions about how
to treat behaviour if it is systemic rather than limited to the occasional
rogue trader.
The first paper starts from the private meetings American government officials
held during the crisis with financial institutions. Not made public at the time
were critical details about what came to be called the Troubled Asset Relief
Programme (TARP), notably how much money would be involved and how it would be
allocated. This mattered hugely. The very survival of some institutions was at
stake; in the end, hundreds of billions of dollars were pledged. Knowing the
structure and scope of the bail-out in advance would have been a vitally
important piece of information for investors during this period.
The paper examines conduct at 497 financial institutions between 2005 and 2011,
paying particular attention to individuals who had previously worked in the
federal government, in institutions including the Federal Reserve. In the two
years prior to the TARP, these people s trading gave no evidence of unusual
insight. But in the nine months after the TARP was announced, they achieved
particularly good results. The paper concludes that politically connected
insiders had a significant information advantage during the crisis and traded
to exploit this advantage.
The other papers use data from 1999 to 2014 from Abel Noser, a firm used by
institutional investors to track trading transaction costs. The data covered
300 brokers but the papers focus on the 30 biggest, through which 80-85% of the
trading volume flowed. They find evidence that large investors tend to trade
more in periods ahead of important announcements, say, which is hard to explain
unless they have access to unusually good information.
They could acquire such information in several ways. The most innocent is that
brokers spread the news of a particular client s desire to buy or sell large
amounts of shares in order to create a market, much as an auction house might
do for a painting. But it is also possible, the papers suggest, that they give
this information to favoured clients to boost their own business. Strengthening
this argument is the finding that large asset managers which use their own
affiliated brokers do not lose out.
Large institutions can be both beneficiaries and victims of this sort of
information leakage. But in general they are net gainers. The real losers, the
papers conclude, are retail customers and smaller asset managers. Common to all
the papers is the recognition that the public markets are, as conspiracy
theorists have long argued, not truly public at all. Changing the law to fix
that may not even be feasible. But at least, in large-scale data-crunching, a
new type of corporate sleuth is on the case.
Jagolinzer, Judge Business School, University of Cambridge; David F. Larcker,
Graduate School of Business, Rock Center for Corporate Governance, Stanford
University; Gaizka Ormazabal, IESE Business School, University of Navarra;
Daniel J. Taylor, the Wharton School, University of Pennsylvania. Rock Center
for Corporate Governance at Stanford University, Working Paper No. 222.
Marco Di Maggio, Francesco Franzoni, Augustin Landler. National Bureau of
Economist Research, Working Paper 24089, December, 2017; and "The Relevance of
Broker Networks for Information Diffusion in the Stock Market" by Marco Di
Maggio, Francesco Franzoni, Amir Kermani and Carlo Summavilla. NBER Working
Paper, No 23522, June, 2017.
This article appeared in the Finance and economics section of the print edition
under the headline "In the know"