Insider trading: Regulation, securities markets and welfare
Estrada, Javier Alejandro
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Permalink
https://hdl.handle.net/2142/22714
Description
Title
Insider trading: Regulation, securities markets and welfare
Author(s)
Estrada, Javier Alejandro
Issue Date
1993
Doctoral Committee Chair(s)
Ulen, Thomas S.
Department of Study
Economics
Discipline
Economics
Degree Granting Institution
University of Illinois at Urbana-Champaign
Degree Name
Ph.D.
Degree Level
Dissertation
Keyword(s)
Economics, Finance
Language
eng
Abstract
Although liquidity and informational efficiency, among others, are important characteristics of a securities market, they are not, or should not be, ends in themselves. From a normative point of view, the ultimate goal is to maximize the welfare of society. Therefore, the critical question about insider trading regulation (ITR) is: Does ITR make society better off or worse off? In this dissertation, I evaluate the impact of ITR on a securities market and on social welfare, paying special attention to the welfare issue.
ITR is shown to have both beneficial and detrimental effects on a securities market. More precisely, ITR is shown to increase market liquidity, decrease current-price volatility, increase future-price volatility, decrease the informational efficiency of the market, and decrease price predictability. In terms of welfare, ITR is (generally) shown to make insiders and workers worse off, outsiders and liquidity traders better off, and society as a whole worse off.
An unregulated market is shown to be an improvement upon a regulated one for three reasons. First, in an unregulated market no resources are diverted to regulatory activities; hence, no production of goods and services is foregone in this market. Second, in an unregulated market securities prices reflect inside information; hence, this market is less risky. And, third, in an unregulated market insiders bear a part of the risk of the volatility of securities prices; hence, there is a superior risk sharing in this market.
Finally, acknowledging that due to the (unfair?) lack of popularity of insider trading there may be no government willing to deregulate this activity completely, an alternative policy is considered: the imposition of a tax on insider trading profits. A change in policy from ITR to the imposition of such a tax is shown to have, from a qualitative point of view, similar effects to those of a complete deregulation of insider trading. In particular, in terms of welfare, such a change in policy is shown to make society better off.
In sum, I argue in this dissertation that society should not waste resources in preventing insiders from trading on their private information. Either a complete deregulation of insider trading, or the replacement of ITR by a tax on insider trading profits would have the same effect: the reallocation of resources to a more efficient use. And that is what economics is all about.
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