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Informed Trading in Regulated Industries

Informed Trading in Regulated Industries. David M. Reeb , Yuzhao Zhang and Wanli Zhao Discussion by Ko -Chia Yu Shanghai University of Finance and Economics 2012 NTU ICF. The bigger picture. Why do governments regulate? To gain control over a certain strategically important sector.

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Informed Trading in Regulated Industries

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  1. InformedTradinginRegulatedIndustries DavidM.Reeb,YuzhaoZhangandWanliZhao DiscussionbyKo-ChiaYu ShanghaiUniversityofFinanceandEconomics 2012NTUICF

  2. Thebiggerpicture • Whydo governments regulate? • Togain control over a certain strategically important sector. • Shareholder protection • Monitoringofwrongdoingofcorporateinsiders • Limittheinformationleakageoftheinsiders

  3. Thebiggerpicture • Summaryoftheresults: • Theveryactofgovernmentalinterventionmightleadtomorepassagesforinformationalleakage. • Additional“insiders”aregeneratedinthemonitoringprocess. Regulators

  4. SummaryofFindings • Averylonglistofevidencethatincludes: • Potentialavenuesforinformedtrading • Short-sales • Equitysalesand/orpurchases • Optionmarket • Potentialinformationalleakageevents • Abnormalshort-salesbeforeearningshocks • NaturalExperiments • 1978Airlinederegulation • 1980Truckingderegulation • 1999Gramm-Leach-BlileyAct(againaderegulation,bankingindustry)

  5. SummaryofFindings • Identification of the channels (Bank industry) • Timing of informational flows • Call report to the regulators by the end of every calendar quarter • Gone public 40 days later • Reaction in the first 20 days of the reports • Federal vs. State supervision • Duplicity increases informed trading. • Political integrity • Interaction between corruption index and supervision

  6. OverallImpression • Verycomprehensiveandwellstructured • Convincingandveryinterestingnaturalexperimentsresults • Manydifferenttakeawaysandpossibleinterpretationsoftheresults • Highlyunlikelyformetopickupanysignificantflawtothecontentsofthearguments

  7. PotentialAvenuesforInformedTrading • Alternativeinterpretationsoftheresults • Regulationprovidesanotherchannelofinformationleakagethusgeneratemore“pseudo-insiders.” • Dotheymitigatetheextentoftradingfromthetrueinsiders? • “Opportunistictrade”variablefromCohenet.al(2010)isincluded • Itisstillinterestingtoseehowinsidertradinginteractswiththeregulator-insidertrading

  8. PotentialAvenuesforInformedTrading • Steele(1989)model:informationleakageasthesquareofthenumberofpeoplewhohaveaccesstotheinformation • Wouldtheresults(themassdatasampleonshort-sales,equityandtheoptionmarkets)bedrivenbythefactthattheseindustries(finance,utilities,andpharmaceuticals)consistofmorepeoplewithvaluableinsiderinformationabouttheindustry? • E.g.Apharmaceuticalresearcherwilllikelyhavethesameinformation(possiblybetterinformation)thanananalyststudyingonthefirm. • Suggestion:average employee salary (NBER data)

  9. PotentialAvenuesforInformedTrading • Short-salemarket • Predictabilityissignificantlybetterforregulated industries than non-regulated industries • However it is not clear that this predictability can be attributed to informed traders or liquidity providers (opportunistic or not). • Diether et al (2007): reversal • Short-sale constraints • Non-transient institutional ownership, index fund ownership (Bushee 1998, among others)

  10. PotentialAvenuesforInformedTrading • Equity market • Adjusted-PIN • Liquidity-PS is controlled. • The asymmetric information part of PIN as in Duarte and Young (2009)

  11. Other comments • Whataboutotherregulatory changes? • Othersupervisedfirms? • Telecomm? • Supervision and regulation (more supervision than regulation, but it is the regulator who conducts the regulatory supervision) • Cost of getting caught seems to be low. (?)

  12. MinorIssues • Table 6 “Regulatory duplicity” got truncated • Punctuation: “Although, …” in several places • Table 9 • Citation update: Adams, R. B., & Ferreira, D. (2012). Regulatory pressure and bank directors’ incentives to attend board meetings. International Review of Finance, 12(2), 227-248.

  13. Conclusion • Theresearchhasa different takeaway for different people. • I really do enjoy reading the paper. • Goodlucktotheauthors!

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