Can traders beat the market? Evidence from insider trades

Can traders beat the market? Evidence from insider trades Purpose – The purpose of this paper is to investigate how insiders’ trades are executed and whether and how outside investors can mimic outperforming insiders and reap substantial portfolio returns that withstand the erosion from adjustments for both the standard factors and stock characteristics in the asset pricing literature. Design/methodology/approach – The authors design a metric for measuring insiders’ trade execution quality: the trading alpha. The authors run regression analysis to control for trade difficulty, insider reputations and the corporate role ranks of insiders and document the existence of the abnormal trading alpha. The authors further form portfolios based on the abnormal trading alpha and document a significant abnormal return that is robust to both standard asset pricing factors model and the stock characteristics adjustments. Findings – Outperforming insiders at the aggregate level resemble value investors who trade on long‐term fundamental information, trade patiently and earn rents from providing liquidity. Outside investors can mimic the outperforming insiders and reap significant abnormal portfolio returns. Research limitations/implications – Data limitations on insider trades and their association/interaction with their brokers prevent us from having a conclusive investigation of the trading skill hypothesis. The authors hope to further research along the lines of the trading skill hypothesis as compared to investment style hypothesis with more detailed data about the brokers used by insiders. Practical implications – The findings can be applied for money management profession in that outsider investors can monitor the trading execution and construct portfolios based on the adjusted abnormal trading alpha. The resulting portfolio has been documented to be highly profitable after risk adjustments using standard asset pricing factors as well as stock characteristics. Social implications – Professional money managers and outsider investors should be able to benefit from the findings in this paper and use the proposed trading alpha metric to construct and rebalance real‐time investment portfolios. Originality/value – Outperforming insiders at the aggregate level resemble value investors who act on long‐term fundamental information, trade patiently and earn rents from providing liquidity. From the perspective of investment implications, outside investors can mimic the outperforming insiders and reap substantial portfolio returns that withstand the erosion from adjustments for both the standard factors and stock characteristics in the asset pricing literature. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png China Finance Review International Emerald Publishing

Can traders beat the market? Evidence from insider trades

China Finance Review International, Volume 4 (3): 28 – Aug 12, 2014

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Publisher
Emerald Publishing
Copyright
Copyright © 2014 Emerald Group Publishing Limited. All rights reserved.
ISSN
2044-1398
D.O.I.
10.1108/CFRI-02-2014-0006
Publisher site
See Article on Publisher Site

Abstract

Purpose – The purpose of this paper is to investigate how insiders’ trades are executed and whether and how outside investors can mimic outperforming insiders and reap substantial portfolio returns that withstand the erosion from adjustments for both the standard factors and stock characteristics in the asset pricing literature. Design/methodology/approach – The authors design a metric for measuring insiders’ trade execution quality: the trading alpha. The authors run regression analysis to control for trade difficulty, insider reputations and the corporate role ranks of insiders and document the existence of the abnormal trading alpha. The authors further form portfolios based on the abnormal trading alpha and document a significant abnormal return that is robust to both standard asset pricing factors model and the stock characteristics adjustments. Findings – Outperforming insiders at the aggregate level resemble value investors who trade on long‐term fundamental information, trade patiently and earn rents from providing liquidity. Outside investors can mimic the outperforming insiders and reap significant abnormal portfolio returns. Research limitations/implications – Data limitations on insider trades and their association/interaction with their brokers prevent us from having a conclusive investigation of the trading skill hypothesis. The authors hope to further research along the lines of the trading skill hypothesis as compared to investment style hypothesis with more detailed data about the brokers used by insiders. Practical implications – The findings can be applied for money management profession in that outsider investors can monitor the trading execution and construct portfolios based on the adjusted abnormal trading alpha. The resulting portfolio has been documented to be highly profitable after risk adjustments using standard asset pricing factors as well as stock characteristics. Social implications – Professional money managers and outsider investors should be able to benefit from the findings in this paper and use the proposed trading alpha metric to construct and rebalance real‐time investment portfolios. Originality/value – Outperforming insiders at the aggregate level resemble value investors who act on long‐term fundamental information, trade patiently and earn rents from providing liquidity. From the perspective of investment implications, outside investors can mimic the outperforming insiders and reap substantial portfolio returns that withstand the erosion from adjustments for both the standard factors and stock characteristics in the asset pricing literature.

Journal

China Finance Review InternationalEmerald Publishing

Published: Aug 12, 2014

Keywords: Transaction costs; Insider trading; Investment style; Trading alpha; VWAP

References

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