Insider Trading

There is a long-lasting debate on whether emph{insider trading (IT)}, defined as trading in possession of material private information, should be allowed or forbidden and, even now, it is not clear what the optimal IT regime might be. IT regulation, and whether this regulation is enforced, differs across countries. For instance, IT laws are lax in Norway, and Mexico and strict in the US and Ireland; however, there have been enforcement cases in Norway and the US, but never neither in Mexico nor in Irelandfootnote{See cite{Beny:2005} and cite{FerreiraFernandes:2009}.}. There are differences in what is considered illegal IT between American and European regulations: in the US, under Rule 10b-5, anyone in possession of material inside information shall disclose his private information or abstain from tradingfootnote{The origin of this interpretation can be traced to emph{SEC v. Texas Gulf Sulphur Co}, although latter the Supreme Court limited the liability to the cases in which there is a fiduciary duty of the insider to the persons with whom he trades (emph{Chiarella v. US}), to tippees (emph{Dirks v. SEC}), and to the cases in which there is a fiduciary duty of the insider to the source of the information (the so-called misappropriation theory, endorsed by the Supreme Court in emph{US v. O'Hagan}).}; in Europe, directive 2003/6/EC on insider dealing and market manipulation requires ``inside information'' to be of a ``precise nature", and forbids both, trading in possession of inside information and the disclosure of this information, ``unless such disclosure is made in the normal course of the exercise of his employment, profession or duties".

This debate on the optimal IT regulation is due, in part, to the fact that th...

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...all the effects and trade-offs that have been discussed in the literature.footnote{For instance, the effects of the interaction of multiple insiders (cite{EdelsteinSureda-GomilaUrosevic:2010}), whether IT reduces the incentives of other market participants to gather information (cite{FishmanHagerty:1992,KhannaSlezak:1994,BushmanPiotroskiSmith:2005}), or the impact of IT on the cost of capital (cite{BhattacharyaDaouk:2002,Beny:2005}).}

This paper is structured as follows. In the next section I relate this work to the previous literature. The model is described in section ef{sec:model}. Section~ ef{sec:Equilibrium} defines and describes the equilibrium of the model and, in section~ ef{sec:WelfareAnalysis}, I perform the welfare analysis. Section~ ef{sec:Conclusions} concludes. Proofs and details regarding the numerical analysis are provided in the appendix.