6 - Trading gone awry Flashcards
Pareto efficiency
exists when no other feasible allocation of resources and technology can improve one person’s situation without harming that of another
Informational efficiency
achieved when all investors hold objective beliefs and information in common, so that competitive prices accurately reflect that information
Fairness can be thought of a claim to certain entitlements:
- efficient prices
- equal bargaining power
- equal information
Inside information
material information obtained from management that is not widely available to the public
Managers must control the dissemination of material managerial information
must be either widely publicized or kept secret
Illegal insider trading:
execution of transactions on the basis of material non-public information
- US: violation of a relationship of trust and confidence
Registered insiders are forbidden from trading on material non-public information based on:
- the disclose or abstain theory
- the misappropriation theory
inside information australia:
information that is not generally available, which is likely to have an effect on the value of a financial product
Why have insider trading rules?
- public demands fairness
- other traders have a right to equal information
- to protect dealers and limit order traders from inside traders
- to remove unwanted distortions in managerial labour markets
What are likely effects of insider trading rules?
- effectively enforced insider trading rules see reduction in the adverse selection spread components
- more capital will be saved by uninformed traders when liquidity is cheap, and markets are widely believed to be fair
- prices may be less efficient in the short run
Arguments for permitting insider trading:
- insider trading rules cost too much to enforce
- insider trading may increase liquidity by quickly eliminating information asymmetries
Corporate problems with insider trading
- Hides information from public
- Increases information asymmetry
- Front running corporate trading
Market manipulation
act or transaction that is intended to or likely to have the effect of creating or maintaining an artificial price level in a security
Action-based manipulation
manipulation based on actions that change the actual or perceived value of the assets
Information-based manipulation
manipulation based on releasing false information or spreading false rumors
Trade-based manipulation
manipulation based on buying and selling of securities without observable actions to alter the value of the firm or releasing information to change the price
Market manipulation trading
satisfies 3 conditions:
1) trader’s wealth after liquidation of the position is expected to be greater than the amount of wealth required to initiate the position
2) trade is not an arbitrage opportunity that would be available to small investors
3) strategy is independent of information
Action-based and information based manipulation are effectively outlawed
but trade based manipulation is harder to eradicate
Manipulation is possible only when market structure departs from perfect markets
e.g less information asymmetry
