Are Insider Trades Informative?

Lakonishok & Lee [2001]

Siraprapa Watakit 5502310013

Agenda
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Overview of The Paper Contribution Data and Data Summary

Trading and Reporting Periods Returns Aggregate Insider Trading and Market Returns
InsidersTrades and Cross-Sectional Variation in Stock Returns Conclusion

Overview of The Paper

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The paper aims at investigating whether the insider trading is informative and how will the market react to insider trading information Insiders are those people who are deemed to have more information about company; such people are management, CEO or people who hold substantial wealth of company(10%) The activity of insiders are heavily demanded. it is still debatable whether outsiders can profit from knowing Some research say yes, and some say no How best to interpret these signals is the main objective of this article.

Contribution
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Using large data sample of insider trading, the paper presents empirical result supporting the statement that insider trading IS informative? Insider trading gain profit from purchasing small stocks; no evidence to support that there is profit gain on selling small stock Even though outsider learn this information, trading small stock is still costly, thus profit will be offset by transaction cost Insider seems to have predictive/timing ability. The valuable information is initially ignored by the market but later (6M later) realizing this information(market underreaction)

Data
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Stock Exchanges: NYSE/AMEX and NASDAQ(Excludes: noncommon share, ETF, ADR, cheap stock <$2,), 1975-1995 Insider Trading Information : SEC, ORS(Excludes: Transaction less than 100 shares) Classification: Management Group, Large Shareholder(Exempt Banks, Financial Institutes), Others Type of Trading: Purchase, Sale, Option 3 Firm Size Group: Large(top3decile), Medium(4middle decile), Small(last3decile) based on market capitalization 3 B/M Equity Group: Large(top3decile), Medium(4middle decile), Small(last3decile) based on B/M

Data Summary
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Table1: Managers are most active in Large Company Manager sell >buy LargeSH trade much less often but in much bigger volume Insider activity is more pronounces in small company

Data Summary
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Table 2 Overtime, managers wealth are in company stock; in order to diversify their wealth, sales are expected to increase (from $2.6B to $23B)

Trading and Reporting Periods Returns

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To study a market reaction, abnormal return are calculated at around the time of insider trading reporting Table 3

the abnormal returns around the reporting dates of insiders trades are not economically meaningful and not related /w size the abnormal returns around the trading dates of insiders trades are somewhat larger in purchase and small stock

Aggregate Insider Trading and Market Returns

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Seyhun(1988,1992,1998) shows that aggregate insider trading significantly predicts future market movements Methodology: Distinguish between contrarian strategy and insider trading activity by using NPR Calculate NPR for each group in each month during Jan/76 to Jan/95, then run regression
prior2y holding period return (control contrarian)

return of portfolio i which includes no-inside trading stock

Net Purchase Ratio, a measurement of insider activity

Aggregate Insider Trading and Market Returns

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Table 4

1 on the left 2 on the righ

1 is significant suggest insider trading can gain abnormal return

negative 2 on control overstating insider trading abnormal return manager have more predictive power than large sh

Aggregate Insider Trading and Market Returns

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Figure 1

1987 Crash Before: Manager become a heavy seller After: Manager become a heavy buyer

Aggregate Insider Trading and Market Returns

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Other statistics also show that Insider trader are a better contrarian than outsider Insider do not tend to buy when there is a large increase in market return Insiders were heavy buyers after poor performance of the market Managers are more contrarian than large share holder

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InsidersTrades and Cross-Sectional Variation in Stock Returns

Insiders are definitely active in trading their own stocks, the next question is will they have ability to predict to predict cross-sectional variations in stock returns? form portfolio based on NPR decile Highest NPR port consist with small stock, Highes NPR port also outperform Lowest NPR port Purchase are more informative than sales Highest NPR port is associated with poor past performance

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InsidersTrades and Cross-Sectional Variation in Stock Returns

Regression analysis crssectional regression

DPL and DSL dummy for strong purchase*/sale signal

Conclusion
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Insider trading activity is informative to be more precisely, the activity is very informative on purchasing side of the small stocks Insider is a better contrarian Manager is more contrarian than Large share holder Market initially ignores the insider trading information at the reporting period market is under-react Insider have ability to time the market and to predict the trend of the market in cross-section Using daily/montgh data,we can learn about insider trading in a longer period