Research: Insider trading likely rife

Researchers have developed a new model to predict the frequency of insider trading based on previously prosecuted insider trading cases in the United States across the past 21 years, alongside daily stock prices and trading activity. The results indicate that insider trading is at least four times what regulators believe, or at least is four times the number of prosecutions

The researchers, Vinay Patel and Talis Putnins from the University of Technology Sydney, estimate that insider trading occurs in one in five mergers and/or acquisitions and one in 20 quarterly earnings announcements. These data imply a lot more insider trading than is brought before the courts.

Patel and Putnins also estimate the probability of detection or prosecution of insider trading in both mergers and acquisitions and earnings announcements is about 15 per cent.

Mergers and acquisitions are price-sensitive and frequent announcements by companies, so insider trading is more likely. Insider trading is also more likely to be prosecuted as it relates to a merger or acquisition.

The researchers also noted that insider trading is more likely when liquidity is high, as it allows traders doing inside jobs to conceal trades and earn higher profits, particularly when the value of information is larger in terms of market reactions to the announcements. Volatile stocks that undergo greater share price movements, and popular stocks that see a high volume of trades, are frequent targets.

The researchers added that: "Given the substantial penalties for convicted insider trading violations including financial, reputational, and potential jail time, and smaller potential profits, the probability of detection and prosecution has to be relatively low otherwise no one would attempt it."

Read the full paper: How Much Insider Trading Happens in Stock Markets?