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The Handbook of Equity Market Anomalies: Translating Market Inefficiencies into Effective Investment Strategies by Leonard Zacks

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Chapter 7

The Insider Trading Anomaly

Ian Dogan

Insider trading is among the most profitable stock market anomalies, delivering superior returns for more than 40 years. It can be implemented successfully not only in the United States but in several other countries. Insiders have access to nonpublic detailed information about recent and imminent developments in their companies, so they have the expertise to judge the effects of material nonpublic information on their business results and stock returns. In fact, it wouldn't be an exaggeration to claim there's no one out there who's more informed than an insider is. Moreover, insiders have the essential background to utilize this advantage. As a result, it's not a big surprise insiders profit from their transactions. The abnormal returns are not limited to small and risky stocks; several hundred millions of dollars can be invested profitably in large cap stocks as well. Naturally, there's significant demand for insider trading data by individuals and institutional investors.

This chapter provides a brief definition of insider trading, explains laws and regulations governing insider transactions, addresses why insider transactions are profitable, and explores the challenges of imitating insiders. Summaries of notable studies on this topic are shown, as well as a detailed documentation of insider trading returns covering a 27-year period, the longest among existing studies. Results summarized by year, firm size, different holding periods, ...

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