Insider trading was first outlawed in the United States by the Securities and Exchange Act of 1934. The major motivation for the ban was to increase the public's confidence that they could invest in financial securities without being taken to the cleaners by insiders who had a major informational advantage. [0]
Economic theory does lend some support for the idea that markets will perform better when the public is confident enough to participate in them broadly, and broad participation should drive valuations higher. (The latter is a dubious benefit.) But there is likewise plenty of theoretical justification for the harm done to markets by insider-trading laws. Markets are basically mechanisms for aggregating and analyzing information, and insider trading laws restrict the supply of basic facts. Mispricing ensues.
There are other justifications for banning insider trading, albeit all rationalizations post facto, as far as the legal history goes. Allowing a manager to trade her company's shares (particularly to short them) can put her incentives out of step with those of the company's other shareholders. But the managerial misbehavior that could provoke is already illegal under various other regimes. And the principal-agent problem is no argument at all for setting up a system like we have, one which bans trading by knowledgeable people who are in no position to influence corporate decisions.
But the economics are almost beside the point. The promise made by insider trading laws is that any Joe Schmoe can trade on the same footing as sophisticated professional investors, and that promise is a farce. It's a farce not only because the incentives will always drive some people to break insider trading laws, but because ordinary people do not have ready access to all of the legally "public" facts anyway; many of them are locked up in obscure or expensive databases. And if Joe Schmoe did have all the public facts, he would still lack the other big piece of the informational puzzle, which is the ability to interpret the facts properly. That more than anything requires real expertise.
In my opinion, the public-confidence angle is the strongest component of the case for outlawing insider trading, but I think it's a rather weak case in the end. The perverse truth is that if insider trading laws inspire the public to think they can play the markets on equal footing with sophisticated investors, then insider trading laws have succeeded in installing a false confidence; they have hoodwinked the public.
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0. This has remained a main justification (at least rhetorically) for maintaining and strengthening insider trader laws over the past eight decades. For example, an act amending the rules in 1984 has this preamble: "Insider trading threatens ... markets by undermining the public’s expectations of honest and fair securities markets where all participants play by the same rules."
However, even though Joe Schmoe cannot process all of the facts, he can have at least some confidence that the (considerably large) network of sophisticated professional investors competing with eachother have done the research, have made their plays, and as a result the intelligence has already been priced into the stock.
Unlike the case where a very small group of investors privy to truly secret information can collude to keep the secret information out of the stock price, to their eventual gain.
Which side of this do you intend to argue? Insider trading laws actually slow down the transfer of information from the insiders to the rest of the market. The situation is a prisoners' dilemma, in which the first insider to sell (or take whatever action) will be rewarded most, but all insiders benefit from delaying that (and arguably the rest of us suffer from that delay). So these laws actually help the insiders punish defectors, which keeps secret information secret.
The promise made by insider trading laws is that any Joe Schmoe can trade on the same footing as sophisticated professional investors, and that promise is a farce.
Well that promise certainly is a farce. Any insider action that the law can prevent (which let's face it is only a fraction of the possible insider actions) is going to "reduce" (not really) the insiders' edge over the sophisticated professionals more than it reduces the sophisticated professionals' edge over Mr. Schmoe. Of course, an edge is just information that hasn't yet reached all market participants.
Right. I would say that the basic reason for insider trading laws is the idea that insider trades create an incentive in the market to keep secrets secret, because you're making money off of that secret. Aside from the possibility that this has to ruin companies and the difficulty with prosecuting it as negligence, it still might make sense to support insider trading laws in the name of corporate transparency.
I'm curious, given that I've heard lots of of amatur groups and even monkeys do better than the pros is all that like fake propaganda to throw us off that the pros really are better because of their inside knowledge or is it that only some of the pros have this knowledge so in aggregate it appears the pros don't benefit from it or something else? Or am I conflating something I shouldn't?
Amateurs tend to be much worse at limiting risk, so while they can win bigger, their drawdown/losses tend to be much higher than the professionals, too.
If you want to see how good a trader someone is, look at how much they lose in a bad market rather than how much they make in a good market.
If you look at something like a mutual fund, they will say something like X% performance over X years. BUT what they also do is remove poorly performing positions from their portfolio.
As they are not part of the portfolio they can avoid reporting on the performance, so you don't necessarily get to see the full picture of how their decisions affect their investors.
The random selection (group of monkey) works well during the periods of economic upheaval, when smallcap and microcap do well, and doesn't do as much during the economic downturn.
Random selection tends to bias towards smallcap/microcap, as the sheer quantity of those companies is higher.
Economic theory does lend some support for the idea that markets will perform better when the public is confident enough to participate in them broadly, and broad participation should drive valuations higher. (The latter is a dubious benefit.) But there is likewise plenty of theoretical justification for the harm done to markets by insider-trading laws. Markets are basically mechanisms for aggregating and analyzing information, and insider trading laws restrict the supply of basic facts. Mispricing ensues.
There are other justifications for banning insider trading, albeit all rationalizations post facto, as far as the legal history goes. Allowing a manager to trade her company's shares (particularly to short them) can put her incentives out of step with those of the company's other shareholders. But the managerial misbehavior that could provoke is already illegal under various other regimes. And the principal-agent problem is no argument at all for setting up a system like we have, one which bans trading by knowledgeable people who are in no position to influence corporate decisions.
But the economics are almost beside the point. The promise made by insider trading laws is that any Joe Schmoe can trade on the same footing as sophisticated professional investors, and that promise is a farce. It's a farce not only because the incentives will always drive some people to break insider trading laws, but because ordinary people do not have ready access to all of the legally "public" facts anyway; many of them are locked up in obscure or expensive databases. And if Joe Schmoe did have all the public facts, he would still lack the other big piece of the informational puzzle, which is the ability to interpret the facts properly. That more than anything requires real expertise.
In my opinion, the public-confidence angle is the strongest component of the case for outlawing insider trading, but I think it's a rather weak case in the end. The perverse truth is that if insider trading laws inspire the public to think they can play the markets on equal footing with sophisticated investors, then insider trading laws have succeeded in installing a false confidence; they have hoodwinked the public.
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0. This has remained a main justification (at least rhetorically) for maintaining and strengthening insider trader laws over the past eight decades. For example, an act amending the rules in 1984 has this preamble: "Insider trading threatens ... markets by undermining the public’s expectations of honest and fair securities markets where all participants play by the same rules."