Can traders beat the market? Evidence from insider trades

Qin Lei (Stephen Ross School of Business, University of Michigan, Ann Arbor, Michigan, USA)
Murli Rajan (Department of Economics and Finance, Kania School of Management, University of Scranton, Scranton, Pennsylvania, USA)
Xuewu Wang (Department of Economics and Finance, Kania School of Management, University of Scranton, Scranton, Pennsylvania, USA)

China Finance Review International

ISSN: 2044-1398

Publication date: 12 August 2014

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.

Keywords

Citation

Qin Lei, Murli Rajan and Xuewu Wang (2014) "Can traders beat the market? Evidence from insider trades", China Finance Review International, Vol. 4 No. 3, pp. 243-270

Download as .RIS

DOI

: https://doi.org/10.1108/CFRI-02-2014-0006

Publisher

:

Emerald Group Publishing Limited

Copyright © 2014, Emerald Group Publishing Limited

Please note you might not have access to this content

You may be able to access this content by login via Shibboleth, Open Athens or with your Emerald account.
If you would like to contact us about accessing this content, click the button and fill out the form.
To rent this content from Deepdyve, please click the button.