Leveling the Playing Field: Can Private Investors Benefit From Mimicking Insider Trades? A quantitative study of insider trading

Abstract: Historically, investors have been searching for strategies to maximize performance in the stock market. It has been shown that corporate insiders can earn abnormal returns by trading in their own companies as they possess superior information and, to a certain degree, market timing ability. As the EU tries to cut down on market abuse, a new regulation was introduced mandating insiders to report and publish trades within three business days. While many studies have investigated the possibility for insiders to earn abnormal returns, far fewer have explored the ability for outsiders to mimic insiders as an investment strategy. This study contributes to this rather scarce research area by investigating the possibility of earning abnormal returns by mimicking insider trades in Sweden, and if the magnitude of the returns depend on the position of the insider that is mimicked. Through the use of an event study, we examine insider buy and sell transactions and aim to answer the following: Can outside investors earn abnormal returns by mimicking insiders in the Swedish stock market and does the position of the insider affect the magnitude of the returns? We find that outsiders are able to earn abnormal returns in the short term by mimicking insiders’ buy and sell transactions. While mimicking an insiders sell transaction is found to be beneficial for up to five days after the event, mimicking buy transactions is only found to be profitable during a three day event window. When comparing these results to the abnormal returns earned by the insiders themselves, we find that they are able to earn abnormal returns for longer as the reaction to the perceived event does not happen during the date of the publication but closer to, or during, the date of the transaction. We hypothesize that the market observes abnormal trading activity during the transaction day and trades are made based on this information. For both buy and sell transactions, company size is found to have the greatest effect where investors trading in smaller companies are able to earn greater abnormal returns. A possible explanation for this relationship is that the information asymmetry present between smaller companies and outsiders is larger than that between larger companies and outsiders. Additionally, we find that mimicking top executives such as CEOs and CFOs as well as board members is superior compared to lower level insiders. While no significant difference is found between top executives and board members, mimicking CFOs enables outsiders to earn the greatest abnormal returns on average.