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Who Are They?

Who Are They?. Does Insider Trading Raise Stock Market Volatility? (Economic Journal, Oct 2004). Julan Du Chinese U of HK and Shang-Jin Wei IMF and NBER. Market Volatility. standard deviation of monthly stock returns over 1985:1 - 1998:12. Stock Market Volatility.

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Who Are They?

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  1. Who Are They?

  2. Does Insider Trading RaiseStock Market Volatility?(Economic Journal, Oct 2004) Julan Du Chinese U of HK and Shang-Jin Wei IMF and NBER

  3. Market Volatility • standard deviation of monthly stock returns over 1985:1 - 1998:12

  4. Stock Market Volatility

  5. Is volatility good or bad? • signal

  6. What Explains the Cross-Country Dispersion? • Fundamentals • output, cash flow, leverage, concentration • Macro Policies • monetary, exchange rate & Fiscal policies • Liquidity • Maturity • Integrity • Insider trading, Disclosure/accounting

  7. Market Volatility vs. Output Volatility .3 RUS ARG .2 PER TUR CHN Volatility of Stock Market Return in US$ NGA VEN IDN MEX HUN THA KOR GRC PHL ZWE PRT MYS .1 CZE IND HKG NOR ZAF LKA PAK COL CHL SVK EGY ESP FIN ISR SGP ITA SWE IRL AUT FRA AUS JPN DEU LUX CHE DNK CAN NZL BEL JOR MAR SAU GBR NLD USA 0 0 .02 .04 .06 .08 Volatility of Real GDP Growth Rate

  8. Role of Fundamentals_____________________________________

  9. Market volatility vs. Inflation volatility .3 RUS .2 TUR CHN Volatility of Stock Market Return in US$ NGA VEN IDN MEX TWN HUN THA KOR GRC PHL ZWE PRT MYS .1 CZE IND HKG NOR ZAF LKA PAK COL SVK CHL EGY ESP FIN ISR SGP ITA SWE IRL AUT FRA AUS JPN DEU LUX CHE DNK CAN NZL BEL JOR MAR SAU GBR NLD USA 0 0 50 100 Volatility of Inflation Rate (ARG & PER dropped)

  10. Market volatility vs. Interest rate volatility .3 RUS .2 TUR CHN Volatility of Stock Market Return in US$ NGA VEN IDN MEX TWN HUN THA KOR GRC PHL ZWE PRT MYS .1 CZE IND HKG NOR ZAF LKA PAK COL SVK CHL EGY ESP FIN ISR SGP ITA SWE IRL AUT FRA AUS JPN DEU LUX CHE DNK CAN NZL BEL JOR MAR GBR NLD USA 0 0 .5 1 Volatility of Real Interest Rate (ARG & PER dropped)

  11. Market Volatility vs. Fiscal Policy Volatility .3 RUS ARG .2 PER TUR CHN NGA Volatility of Stock Market Return in US$ VEN IDN MEX HUN THA KOR GRC PHL ZWE PRT MYS .1 CZE IND NOR ZAF LKA PAK COL CHL EGY ESP FIN ISR SGP ITA IRL SWE AUT FRA AUS JPN DEU LUX CHE DNK CAN NZL BEL JOR MAR GBR NLD USA 0 0 2 4 6 Volatility of Fiscal Deficit/GDP

  12. 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

  13. 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

  14. Market Volatility vs. Market Maturity .3 RUS ARG .2 PER TUR CHN Volatility of Stock Market Return in US$ NGA VEN IDN MEX HUN THA GRC PHL ZWE PRT MYS .1 CZE IND HKG NOR ZAF LKA PAK COL SVK CHL EGY ESP FIN ISR SGP ITA IRL SWE AUT FRA AUS JPN DEU CHE DNK CAN NZL BEL JOR MAR SAU GBR NLD USA 0 0 50 100 150 Market Capitalization/GDP (LUX dropped)

  15. Market Volatility vs. GDP per capita .3 RUS ARG .2 PER TUR CHN Volatility of Stock Market Return in US$ NGA VEN IDN MEX TWN HUN THA KOR GRC PHL ZWE PRT MYS .1 CZE IND HKG NOR ZAF LKA PAK COL CHL SVK EGY ESP FIN ISR SGP ITA IRL SWE AUT FRA AUS JPN DEU LUX CHE DNK CAN NZL BEL JOR MAR SAU GBR NLD USA 0 6 8 10 Log of Per Capita GDP

  16. Market Integrity • Insider trading • Information Disclosure

  17. Variations in Insider Trading Prohibition • Laws on the book • “Corporate Insiders” • “Constructive Insiders” • “Tipees” • “Mis-appropriators”

  18. 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 volatility Reduce efficiency Insider Trading on market volatility

  19. 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

  20. 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 Measuring Market Integrity

  21. 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

  22. Market Volatility vs. Insider Trading .3 RUS ARG .2 PER TUR CHN Volatility of Stock Market Return in US$ VEN IDN MEX TWN HUN THA KOR GRC PHL ZWE PRT MYS .1 CZE IND HKG NOR ZAF COL CHL SVK EGY ESP FIN ISR SGP ITA IRL SWE AUT FRA AUS JPN DEU LUX CHE DNK CAN NZL BEL JOR GBR NLD USA 0 0 1 2 3 Insider Trading Index

  23. Table 2: Insider Trading & Market Volatility

  24. Table 4: Adding Volatility of Macro Policies (IV)

  25. An Example

  26. 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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