Who Are They?

Does Insider Trading Raise Stock Market Volatility? (Economic Journal, Oct 2004) Julan Du Chinese U of HK and Shang-Jin Wei IMF and NBER

Market Volatility zstandard deviation of monthly stock returns over 1985: :12

Stock Market Volatility

Is volatility good or bad? zsignal

What Explains the Cross- Country Dispersion? zFundamentals youtput, cash flow, leverage, concentration zMacro Policies ymonetary, exchange rate & Fiscal policies zLiquidity zMaturity zIntegrity yInsider trading, Disclosure/accounting

Market Volatility vs. Output Volatility Volatility of Stock Market Return in US$ Volatility of Real GDP Growth Rate NLD AUT COL ITA DEU DNK FRA BEL EGY GRC LKA IDN NOR USA CHE AUS ESP SWE JPN PRT GBR CAN IND ISR CHL KOR ZAF NZL PAK LUX CHN IRL HKG MYS THA NGA SGP PHL FIN SAU MEX TUR HUN ZWE VEN CZE RUS MAR ARG SVK JOR PER

Role of Fundamentals _____________________________________

Market volatility vs. Inflation volatility Volatility of Stock Market Return in US$ Volatility of Inflation Rate (ARG & PER dropped) NZL TWN SAU SVK AUT BEL USA NLD JPN FRA DNK SGP DEU MAR CZE MYS ZAF EGY CAN ITA THA CHE FIN ESP LUX KOR GBR NOR IND SWE PRT COL LKA HUN GRC PHL AUS HKG IRL CHL JOR CHN PAK ZWE IDN TUR NGA VEN RUS MEX ISR

Market volatility vs. Interest rate volatility Volatility of Stock Market Return in US$ Volatility of Real Interest Rate (ARG & PER dropped) SVK NLD DEU CHE AUT JPN USA FIN MYS LUX NOR NZL ITA GBR SWE CAN SGP THA HKG CZE DNK KOR ESP BEL IND IRL PRT FRA PAK GRC MAR COL AUS ZAF HUN PHL EGY ZWE CHN JOR IDN CHL LKA TUR VEN NGA MEX RUS ISR TWN

Market Volatility vs. Fiscal Policy Volatility Volatility of Stock Market Return in US$ Volatility of Fiscal Deficit/GDP CHN DEU CHE AUT KOR PAK CAN CZE IND CHL USA NLD ARG IDN ESP PHL TUR FRA AUS ZWE MAR LKA JPN COL BEL DNK HUN ISR ZAF NGA PER GBR NZL ITA THA VEN PRT NOR MYS IRL RUS EGY LUX JOR GRC SWE SGP FIN MEX

Adding Macro Policies zInflation and exchange rate volatility add to stock market volatility zFiscal deficit does not matter for volatility zVolatility of output growth and leverage ratio continue to add to market volatility zCash flow risk no longer significant

Market Liquidity and Market Maturity zLiquidity (ratio of market turnover to market capitalization) is insignificant. zThree proxies for maturity: market cap/GDP, age of the exchange and GDP per capita zA larger market cap/GDP or a higher GDP/capita is associated with a lower market volatility zMkt cap/GDP becomes insignificant once fundamentals/ macro policies are accounted for

Market Volatility vs. Market Maturity Volatility of Stock Market Return in US$ Market Capitalization/GDP (LUX dropped) RUS IDN CHN TUR HUN ARG MAR COL VEN PER NGA EGY PAK GRC LKA AUT MEX SVK IND ZWE PHL ISR THA PRT NOR CZE IRL ITA DEU FRA ESP DNK CHL FIN NZL JOR BEL SAU NLD CAN AUS SWE USA MYS CHE GBR SGP HKG JPN ZAF

Market Volatility vs. GDP per capita Volatility of Stock Market Return in US$ Log of Per Capita GDP IND PAK LKA CHN IDN EGY PHL NGA ZWE MAR THA COL PER TUR JOR MYS CHL ZAF MEX HUN SVK KOR VEN RUS CZE ARG PRT GRC TWN ESP IRL ISR NZL HKG SGP SAU GBR ITA AUS AUT BEL NLD FIN FRA CAN DNK JPN SWE USA NOR LUX CHE DEU

Market Integrity zIzI nsider trading zIzI nformation Disclosure

Variations in Insider Trading Prohibition zLaws on the book z“Corporate Insiders” z“Constructive Insiders” z“Tipees” z“Mis-appropriators”

Insider Trading on market volatility zAllows faster information realization zReduce noise in the price zReduce volatility zImprove efficiency z Insiders can benefit from volatility z May choose riskier projects z May manipulate the timing/content of information release z Increase volatility z Reduce efficiency

Previous empirical work zLegal trading by corporate insiders y-- only legal trades y-- single country studies (US and UK) zIllegal inside trading as uncovered by the regulators y-- single country study (US) y-- possible selection bias

Measuring Market Integrity zInsider trading yLaws on the book yActual Prosecution ySurvey of firm executives on the prevalence of insider trading (GCR) yExtent of corruption (ICRG) z Information yAccounting Quality yDisclosure

Insider Trading Index zSubjective index from GCR survey of firms in 53 countries. One of the questions (Q3.13) asked respondents to rate on a 1- 7 how common insider trading is in the domestic stock market zAverage of all respondents for a given country is used as the value of the insider trading index for that country

Market Volatility vs. Insider Trading Volatility of Stock Market Return in US$ Insider Trading Index DEU DNK GBR IRL SGP NZL LUX SWE CHE AUS FIN USA JPN CAN BEL AUTFRA NOR NLD CHL PRT ESP HKG TUR ISR ARG HUN COL ZWE ITA ZAF EGY PER KOR MYS JOR GRC MEX TWN IND RUS IDN PHL CHN THA SVK VEN CZE

Table 2: Insider Trading & Market Volatility

Table 4: Adding Volatility of Macro Policies (IV)

An Example

To Conclude zLack of market integrity contributes to market volatility zThe effect is quantitatively large relative to the effects of economic and policy fundamentals