Stock Essay -- Economy

An active investor invests his all resources to determine the fair value of a stock. However, most of the times, he is unable to acquire a piece of information that is not available in the public domain and that information may alter the probability distribution of his investment decision (James Lorie, 1980). In this phenomenon, an active investor may infer the non-public information by considering corporate insiders’ action in their own stock. Many previous studies (e.g., Jaffe, 1974; Finnerty, 1976a, b; Seyhun, 1986, 1988a, b; Rozeff and Zaman, 1988; Lin and Howe, 1990) document that corporate insiders pursue special information and on that special information, not only insiders are able to earn abnormal profits through trading stocks of own firms but also outsiders also able to earn abnormally by merely mimicking their actions. In financial economies literature, these findings have been considered as a violation of market efficiency. The main objective of this study is to determine market reactions around the day of insider trading and the day of announcements on Indian stock market. We are curious to perform our analysis on Indian data because a major chunk of studies on insider trading are concentrated on the U.S data. Therefore, the analysis of India insider trading data provides an independent outcome to compare with previous studies’ results. Besides, there are enough differences between the US and India market, which indicate that the results of these studies may not be robust in Asia or emerging markets. First difference, the ownership structure of emerging markets’ firms is more concentrated than developed markets’ firms (La Porta et al, 1999). For example, La Porta et al (1998) find that in the Indian firm, the top th... ... to price ratio and size effects of approximately 9% per annum in market model error term. Moreover, Finnerty (1976) finds that insiders most likely to buy their own stock when a firm is a small size and having low BM ratio compared to other firms whose stocks the average insiders are selling. If insiders’ buy tend to be concentrated in small size and low BM firms, the abnormal returns of insider trading information that are calculated by the market model may be significantly differ from zero in the absence of special information. In this paper, we calculate adjusted abnormal returns of insider trading that take into account the size and BM ratio effects. In this methodology, we argue that when we match the firm of insider trading with similar size and BM ratio portfolio, and then adjusted abnormal returns will be originated because of the special information.