Insider Trading and Market Efficiency: Do Insiders Buy Low and Sell High?

Document Type

Article

Publication Date

2-2011

Abstract

The purpose of this study was to test the semi-strong form efficient market hypothesis using insider sale and purchase announcements and their effect on the risk adjusted rate of return of the firms’ stock price. Past studies using varying methodologies, including the risk adjusted model for event study methodology as used in this study, have found conflicting results regarding the form of market efficiency upheld in the United States. By definition, a semi-strong form efficient market would not allow any investor to earn an above normal risk adjusted return or to consistently outperform the market on the basis of publicly available information, such as an insider trade announcement. This study tests the speed of the market’s reaction to an insider trade announcement to determine if the reaction occurs either on or before the event, thus upholding the semi-strong form efficient market hypothesis. The analysis of two sample groups, sale and purchase insider trade announcements, was used to determine if and when the risk adjusted return of the stock price is significantly affected both on the announcement date and during the defined event period. Results for insider sales support the semi-strong form efficient market hypothesis while the insider purchases analysis findings are mixed. The evidence is at odds with the literature as insiders sales/purchases announcements delivered negative/positive signals, respectively. Evidence of pre-announcement trading and an over-reaction effect were also observed. For insider purchases and sales, the insiders follow a pattern of “buying low and selling high”.

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