Market Abuse in the City

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DeuceSevenOff

Economically speaking, insider trading creates market failure; asymmetric information and 'hidden action' create endogeneity in the market that results in the socially efficient outcome not being achieved, i.e. welfare is lost.

This is going to be fun. No, insider trading does not create market failure; it is simply the market correcting an information asymmetry by the usual means, i.e. the signalling function of prices etc. In other words, it is a market working as it should - a market success, rather than a market failure. You also appear to be talking out of your arse and using technical economic terms in the wrong context in order to impress; either that, or you don't know what 'endogeneity' actually means. You may not like how the distribution of the gains from trade is allocated, but this is a political question, not an economic one.

As I explained in my previous post. I'm guessing you don't know how the markets work by your posts, so I'll give you an example. Let's say IBD employee X at investment bank Y knows a much-hyped up deal is about to fall through. The shares in the takeover target Z have jumped up in anticipation of the deal going through. X 'shorts' the stock like there's no tomorrow (i.e. makes a profit when the price goes down) because he knows it will fall significantly when news reaches the market that the deal's gone down the pan. X makes big profits for himself while shareholders lose out. X 'shorting' the stock has negligible negative effects on the price on his/her own, but let's imagine now that everyone with inside information is as crooked as X and doing the same across all markets. Now the losses are significant, and at the expense of the "little guys" with shares in Z.

This is market failure, and any self-respecting government is going to stop this through legislation, otherwise the financial and economic systems will not work properly.

No, it's not. For someone who seems to have a liking for abusing unnecessarily technical economic terminology, you are quite cocky. I'm probably going to need to get you to define market failure at some point if you want to continue this discussion.

To quote Uncle Milt (I'd hope that his Nobel prize will exempt him from accusations that he doesn't know how the markets work), "You want more insider trading, not less. You want to give the people most likely to have knowledge about deficiencies of the company an incentive to make the public aware of that."

What you have apparently missed is that the total wealth after an insider-trading prompted market adjustment is exactly the same as the total wealth after a public press-release prompted market adjustment. All that is different is the distribution. And it remains entirely to be shown that (if comparisons are even meaningful) that the distribution in the first case is less 'efficient' or has less 'welfare' than the distribution in the second case (what makes you think money in the hands of hedge funds creates more welfare than money in the hands of senior employees) without even mentioning the difficult questions of what exactly you mean by efficient, what exactly you mean by welfare and how it's possible to make interpersonal utility comparisons.

Reply 21

SevenDeuceOff

DrunkHamster

This is going to be fun. No, insider trading does not create market failure; it is simply the market correcting an information asymmetry by the usual means, i.e. the signalling function of prices etc. In other words, it is a market working as it should - a market success, rather than a market failure, as every transaction makes the market more Pareto efficient. You also appear to be talking out of your arse and using technical economic terms in the wrong context in order to impress; either that, or you don't know what 'endogeneity' actually means. You may not like how the distribution of the gains from trade is allocated, but this is a political question, not an economic one.

No. Insider dealing creates "hidden actions" by individuals with illegally obtained/used information unobservable by the market. The "quality" of the goods traded, shares in this case, should be exogenous in an efficient market, but is endogenised with insider trading because insider traders can take measures to change it, e.g. recent example was the spreading of malicious rumours about HBOS and shorting the price brought it down by a massive chunk in a single day.

Distributional issues are important, also: abuse of trusted information for personal profits at the expense of others cannot be allowed in a just society. The political issue, to be fair, is probably the bigger issue here--I'll agree.

Reply 22

SevenDeuceOff

DrunkHamster

I agree that at the end of it all, when the previously "inside" information is available to all, the market becomes efficient again. But widespread insider trading can significantly push prices past fair values; do you not think methods such as aggressive shorting create market inefficiency while the information is still non-public?

Reply 23

President_Ben

DeuceSevenOff

e.g. recent example was the spreading of malicious rumours about HBOS and shorting the price brought it down by a massive chunk in a single day.

This is an interesting issue here.

Because there was no information, just rumour. Same 'apparently' applies to Bear Stearns, but that rumour went so far as to be actioned upon, people actually closed their accounts and refused to lend to Bear, so they went bust (but for the 11th hour rescue as Bernanke stated in his most recent testimony to congress).

Is insider trading necessarily a bad thing?

No. I don't think so.

But insider trading facilitates other activity that is definitely a bad thing - ie. pump and dumps, like Enron.

Market Abuse in the City

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