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Who Are They?
Does Insider Trading RaiseStock Market Volatility?(Economic Journal, Oct 2004)
Julan DuChinese U of HK
and
Shang-Jin WeiIMF and NBER
Monthly Returns for US, Hong Kong and China(1992-2000)
-20
-10
0
10
20
30
40
50
Feb-9
2
Jun-
92
Oct
-92
Feb-9
3
Jun-
93
Oct
-93
Feb-9
4
Jun-
94
Oct
-94
Feb-9
5
Jun-
95
Oct
-95
Feb-9
6
Jun-
96
Oct
-96
Feb-9
7
Jun-
97
Oct
-97
Feb-9
8
Jun-
98
Oct
-98
Feb-9
9
Jun-
99
Oct
-99
Feb-0
0
Jun-
00
Oct
-00
month
retu
rn(%
)
rHSI
rSHA
rS&P
Market Volatility
standard deviation of monthly stock returns over 1985:1 - 1998:12
Stock Market Volatility
0
0.05
0.1
0.15
0.2
0.25
0.3
U.S. Hong
Kong
China Russia
U.S.
Hong Kong
China
Russia
Is volatility good or bad?
signal
What Explains the Cross-Country Dispersion?
Fundamentals output, cash flow, leverage, concentration
Macro Policies monetary, exchange rate & Fiscal policies
LiquidityMaturityIntegrity
Insider trading, Disclosure/accounting
Market Volatility vs. Output VolatilityV
olat
ility
of
Sto
ck M
arke
t R
etur
n in
US
$
Volatility of Real GDP Growth Rate0 .02 .04 .06 .08
0
.1
.2
.3
NLD
AUT
COL
ITADEUDNK
FRA
BEL
EGY
GRC
LKA
IDN
NOR
USA
CHEAUS
ESPSWEJPN
PRT
GBRCAN
IND
ISR
CHL
KOR
ZAF
NZL
PAK
LUX
CHN
IRL
HKGMYS
THA
NGA
SGP
PHL
FIN
SAU
MEX
TUR
HUNZWE
VEN
CZE
RUS
MAR
ARG
SVK
JOR
PER
Role of Fundamentals_____________________________________
V(GDP-growth)
1.15**(0.51)
1.70**(0.63)
1.72**(0.63)
Cash flow risk 0.028*(0.018)
0.025(0.018)
Leverageratio
0.020**(0.008)
0.019*(0.008)
Ent Billionairewealth/GDP
0.0001(0.0002)
Heir Billion.wealth/GDP
0.00003(0.00013)
#obs/ad.R2 54 / 0.17 39 / 0.46 39 / 0.45
Market volatility vs. Inflation volatilityV
olat
ility
of
Sto
ck M
arke
t R
etur
n in
US
$
Volatility of Inflation Rate (ARG & PER dropped)0 50 100
0
.1
.2
.3
NZL
TWN
SAU
SVK
AUT
BEL
USANLD
JPNFRA
DNK
SGPDEUMAR
CZEMYSZAF
EGY
CAN
ITA
THA
CHE
FINESP
LUX
KOR
GBR
NORIND
SWE
PRT
COLLKA
HUNGRCPHL
AUS
HKG
IRL
CHL
JOR
CHN
PAK
ZWE
IDN
TUR
NGAVEN
RUS
MEX
ISR
Market volatility vs. Interest rate volatilityV
olat
ility
of
Sto
ck M
arke
t R
etur
n in
US
$
Volatility of Real Interest Rate (ARG & PER dropped)0 .5 1
0
.1
.2
.3
SVK
NLD
DEUCHEAUTJPN
USA
FIN
MYS
LUX
NOR
NZL
ITA
GBR
SWE
CAN
SGP
THA
HKGCZE
DNK
KOR
ESP
BEL
IND
IRL
PRT
FRA
PAK
GRC
MAR
COL
AUS
ZAF
HUNPHL
EGY
ZWE
CHN
JOR
IDN
CHLLKA
TUR
VENNGA
MEX
RUS
ISR
TWN
Market Volatility vs. Fiscal Policy VolatilityV
olat
ility
of
Sto
ck M
arke
t R
etur
n in
US
$
Volatility of Fiscal Deficit/GDP0 2 4 6
0
.1
.2
.3
CHN
DEUCHEAUT
KOR
PAK
CAN
CZEINDCHL
USANLD
ARG
IDN
ESP
PHL
TUR
FRAAUS
ZWE
MAR
LKA
JPN
COL
BELDNK
HUN
ISR
ZAF
NGA
PER
GBRNZL
ITA
THA
VEN
PRT
NORMYS
IRL
RUS
EGY
LUXJOR
GRC
SWESGP FIN
MEX
Adding Macro Policies
Inflation and exchange rate volatility add to stock market volatility
Fiscal deficit does not matter for volatility
Volatility of output growth and leverage ratio continue to add to market volatility
Cash flow risk no longer significant
Market Liquidity and Market Maturity
Liquidity (ratio of market turnover to market capitalization) is insignificant.
Three proxies for maturity: market cap/GDP, age of the exchange and GDP per capita
A larger market cap/GDP or a higher GDP/capita is associated with a lower market volatility
Mkt cap/GDP becomes insignificant once fundamentals/ macro policies are accounted for
Market Volatility vs. Market MaturityV
olat
ility
of
Sto
ck M
arke
t R
etur
n in
US
$
Market Capitalization/GDP (LUX dropped)0 50 100 150
0
.1
.2
.3RUS
IDN
CHNTUR
HUN
ARG
MAR
COL
VEN
PER
NGA
EGY
PAK
GRC
LKA
AUT
MEX
SVKIND
ZWEPHL
ISR
THAPRT
NORCZE
IRLITADEUFRA
ESP
DNK
CHLFIN
NZL JORBELSAUNLDCAN
AUSSWE
USA
MYS
CHEGBR
SGP
HKG
JPN
ZAF
Market Volatility vs. GDP per capitaV
olat
ility
of
Sto
ck M
arke
t R
etur
n in
US
$
Log of Per Capita GDP6 8 10
0
.1
.2
.3
IND PAK LKA
CHN
IDN
EGY
PHL
NGA
ZWE
MAR
THA
COL
PER
TUR
JOR
MYS
CHLZAF
MEX
HUN
SVK
KOR
VEN
RUS
CZE
ARG
PRTGRC
TWN
ESPIRLISR
NZL
HKG
SGP
SAUGBR
ITAAUSAUT
BELNLD
FINFRA
CANDNKJPNSWE
USA
NOR
LUXCHE DEU
Market Integrity
Insider trading
Information Disclosure
Variations in Insider Trading Prohibition
Laws on the book
“Corporate Insiders”
“Constructive Insiders”
“Tipees”
“Mis-appropriators”
Enforcement of Existing Laws/Regulations
Penalties for Violations
Civil PenaltiesCriminal Penalties
Insider Trading on market volatility
Allows faster information realization
Reduce noise in the price
Reduce volatility
Improve efficiency
Insiders can benefit from volatility
May choose riskier projects
May manipulate the timing/content of information release
Increase volatilityReduce efficiency
Previous empirical work
Legal trading by corporate insiders -- only legal trades -- single country studies (US and UK)
Illegal inside trading as uncovered by the regulators -- single country study (US) -- possible selection bias
Measuring Market Integrity
Insider trading Laws on the book Actual Prosecution Survey of firm
executives on the prevalence of insider trading (GCR)
Extent of corruption (ICRG)
Information
Accounting Quality Disclosure
Insider Trading Index
Subjective index from GCR survey of firms in 53 countries. One of the questions (Q3.13) asked respondents to rate on a 1-7 how common insider trading is in the domestic stock market
Average of all respondents for a given country is used as the value of the insider trading index for that country
Market Volatility vs. Insider Trading
Vol
atili
ty o
f S
tock
Mar
ket
Ret
urn
in U
S$
Insider Trading Index0 1 2 3
0
.1
.2
.3
DEUDNK
GBR
IRLSGP
NZLLUXSWE
CHEAUSFIN
USA
JPNCANBEL
AUTFRA
NOR
NLD
CHL
PRT
ESP
HKG
TUR
ISR
ARG
HUN
COL
ZWE
ITA
ZAF
EGY
PER
KORMYS
JOR
GRC
MEXTWN
IND
RUS
IDN
PHL
CHN
THA
SVK
VEN
CZE
Table 2: Insider Trading & Market Volatility
Dependent Variable: Volatility of Stock Returns (in US Dollars)Specification OLS OLS OLS OLS IV IVInsider Trading Index 0.035** 0.017* 0.015# 0.076** 0.052**
(0.006) (0.010) (0.010) (0.030) (0.023)
Volatility of Real 1.471** 1.163* 1.202** 0.488 0.715GDP Growth Rate (0.538) (0.579) (0.583) (0.601) (0.494)
Log Per Capita GDP -0.007 -0.007 0.021 0.011(0.007) (0.008) (0.015) (0.012)
Market Capitalization/GDP -0.005 0.001 -0.017(0.004) (0.098) (0.021)
R-squared 0.24 0.36 0.48 0.48 - -No. of Obs. 52 48 47 46 46 45
Table 4: Adding Volatility of Macro Policies (IV)Dependent Variable: Volatility of Stock Returns (in US Dollars)
Insider Trading Index 0.067** 0.063** 0.058** 0.058**(0.024) (0.027) (0.022) (0.024)
Volatility of Real 0.292 0.326 0.377 0.385GDP Growth Rate (0.657) (0.667) (0.619) (0.633)
Volatility of Inflation Rate 0.003** 0.005 0.003* 0.009(0.002) (0.054) (0.002) (0.052)
Volatility of Fiscal Def./GDP 0.001 0.001 0.001 0.001(0.005) (0.005) (0.005) (0.005)
Log Per Capita GDP 0.016 0.015 0.014 0.013(0.012) (0.013) (0.011) (0.012)
Market Capitalization/GDP 0.001 -0.011 -0.013 -0.012(0.009) (0.023) (0.022) (0.023)
No. of Obs. 44 41 43 41
An Example
US (1)
China (2)
Difference (3)=(2)-(1)
Increase in mkt Volatility
Insider Trading
2.62
4.62
2.00
245 bp
Output Volatility
1.7%
3.0%
1.3%
103 bp
More volatility effect from an in insider trading
>
The volatility effect from an in output volatility
To Conclude
Lack of market integrity contributes to market volatility
The effect is quantitatively large relative to the effects of economic and policy fundamentals
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