Insider Trading Rights: Short-termism and Trading Constraints ( Job Market Paper) SSRN Link
I investigate the effect of trading restrictions on price efficiency in a model with short-term shareholders. I show that insider trading constraints set a floor on prices. More importantly, as trade is the mechanism that transfers information into the price, the market maker’s pricing function has non-constant sensitivity to order flows, with selling orders impacting the price less than positive orders. These two effects decrease price volatility. Prices will be more efficient in good states of the world but lose their informativeness in bad states of the world. Trading constraints will emerge in equilibrium when shareholders have preferences for short-term market prices. In such a case, an increase in cash flow volatility can translate into more severe limitations, while the impact of noise variance depends on the short-term shareholder’s preferences.
Presented at Kenan-Flagler UNC, AFBC 2020, CSEF, SWFA 2021