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Rev Fin 1995; 8:501-543
© 1995 the Society for Financial Studies

Article

Investment and insider trading

D Bernhardt1, B Hollifield2 and E Hughson3
1 Queen's University
2 Faculty of Commerce and Business Administration, University of British Columbia, 2053 Main Mall, Vancouver, BC, Canada V6T 1Z2 and Carnegie Mellon University
3 University of British Columbia, Vancouver, Canada and California Institute of Technology, California, USA

Abstract

We study insider trading in a dynamic setting. Rational, but uninformed, traders choose between investment projects with different levels of insider trading. Insider trading distorts investment toward asset with less private information. However, when investment is sufficiently information elastic, insider trading can be welfare-enhancing because of more informative prices. When insiders repeatedly receive informations, they trade to reveal it when investment is information elastic because good news increases investment and hence future insider profits. Thus, more information is revealed and uninformed agents are exploited less frequently by insiders. Both effects are Pareto-improving. Finally, we consider various insider-trading regulations.


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