Kathleen M. Hagerty

Insider Trading and the Efficiency of Stock Prices

We analyze several aspects of the debate on insider trading regulations. Critics of such regulations cite various benefits of insider trading. One prominent argument is that insider trading leads to more informationally efficient stock prices. We show that under certain circumstances, insider trading leads to less efficient stock prices. This is because insider trading has two adverse effects on the competitiveness of the market: it deters other traders from acquiring information and trading, and it skews the distribution of information held by traders toward one trader. We also discuss whether shareholders of a firm have the incentive to restrict insider trading on their own.

Robust Trading Mechanisms

We consider the problem of designing a trading institution for a single buyer and seller when their valuation of the good is private information. It is shown that posted-price mechanisms are essentially the only mechanisms such that each trader has a dominant strategy. A posted-price mechanism is one where a price is posted in advance and trade occurs if and only if all traders agree to trade.

The Optimal Enforcement of Insider Trading Regulations

Regulating insider trading lessens the adverse selection problem facing market makers, enabling them to quote better prices. An Optimal enforcement policy must balance these benefits against the costs of enforcement. Such a policy must specify (i) the conditions under which the regulator conducts an investigation, (ii) the penalty schedule imposed if an insider is caught, and (iii) a transaction tax to fund enforcement. We derive the policy that maximizes investors welfare. This policy entails investigations following large trading volumes or large price movements or both. Insiders caught making large trades are assessed the maximum penalty, but small trades are not penalized. Given this policy, insiders trade most aggressively on news with an intermediate price impact but refrain from trading on moderate or extreme news.

Synchronicity, instant messaging, and performance among financial traders

Successful animal systems often manage risk through synchronous behavior that spontaneously arises without leadership. In critical human systems facing risk, such as financial markets or military operations, our understanding of the benefits associated with synchronicity is nascent but promising. Building on previous work illuminating commonalities between ecological and human systems, we compare the activity patterns of individual financial traders with the simultaneous activity of other traders—an individual and spontaneous characteristic we call synchronous trading. Additionally, we examine the association of synchronous trading with individual performance and communication patterns. Analyzing empirical data on day traders’ second-to-second trading and instant messaging, we find that the higher the traders’ synchronous trading is, the less likely they are to lose money at the end of the day. We also find that the daily instant messaging patterns of traders are closely associated with their level of synchronous trading. This result suggests that synchronicity and vanguard technology may help traders cope with risky decisions in complex systems and may furnish unique prospects for achieving collective and individual goals.

Equilibrium Bid-Ask Spreads in Markets with Multiple Assets

The paper models the specialist system as a monopolistically competitive market. The demand for the asset is found by solving the investors portfolio problem with transactions costs. These demand equations are used as inputs in the specialists price-setting problem. It is shown that equilibrium prices and hence equilibrium portfolio holdings depend upon the characteristics of the assets and the investors and the number of assets being traded. Conditions are given under which the bid and ask prices will converge to the competitive level as the number of assets increases. Predictive differences between a monopolistically competitive market and a market where specialists collude are also discussed.