How much volume will an illegal insider trade? Evidence from options markets

Abstract

Modelling the volume traded by illegal inside traders is a fairly new area of research. Previous research into insider trading has focused not a comprehensive study on the determinants of volume, but empirical and theoretical work has touched the area. This thesis will aim to consolidate the scattered literature and model the volume traded by someone who has made the decision to trade on that information (i.e. we are not concerned so much with the ‘to trade or not to trade question’ but rather the how much question). The literature assists in finding factors that may cause high volumes of inside trading under the framework of the utility theory of insider trading. These factors are tested on SEC data on prosecuted insider trades for trades executed between 31 May 1994 and 17 October 2007 to find the material determinants of illegal insider trading volumes on the American option markets. Three determinants examined perform as expected: the performance of the underlying stock is negatively correlated with insider trading volumes on the option market, the act of spreading trades over multiple days increases the insider volume traded and the option liquidity on the day/s of the insider trade/s is positively correlation with insider trading volumes. Two determinants perform contrary to what is expected: higher levels of normal trading liquidity reduce insider trading volume and larger amounts of insider trading volume occur after more stringent insider trading regulations are put in place on 23 October 2000. The other factors are insignificant, not influencing the amount of insider trading volume and include: the amount of profit per option, the volume in the underlying stock, the number of relationships to other traders, working for a scrutinised firm and the type of information announcement. Finally, through robustness testing it is indeterminable whether insider trades on the option markets differ significantly from the average trade, however results are presented, which may be usefully interpreted given future research efforts. Since many of the null and unexpected results can be adequately explained, the thesis concludes with the proposition that there is not enough evidence to either prove or disprove the utility theory of insider trading.