Exchange trading rules, surveillance and insider trading : [draft 15 oct 2013]

We examine the impact of stock exchange trading rules and surveillance on the frequency and severity of suspected insider trading cases in 22 stock exchanges around the world over the period January 2003 through June 2011. Using new indices for market manipulation, insider trading, and broker-agency conflict based on the specific provisions of the trading rules of each stock exchange, along with surveillance to detect non-compliance with such rules, we show that more detailed exchange trading rules and surveillance over time and across markets significantly reduce the number of cases, but increase the profits per case

Shorting the Bear: A Test of Anecdotal Evidence of Insider Trading in Early Stages of the Sub-Prime Market Crisis

This article uses trading data in the options market for shares in The Bear Sterns Companies (BSC) during the early stages of the US sub-prime crisis as a laboratory to examine the incidence of insider trading. We take the perspective of a regulator making use of hindsight to identify the most propitious periods for insider trades and to identify market activity indicative of insiders. Half the value of options traded were on 19 percent of the days, mostly in contracts in or close-to the money and near to expiry. We find persuasive evidence that insiders could have been active in trading Bear Sterns stock during this period.insider trading, forensic finance, Bear Sterns

Pre-Bid Run-Ups Ahead of Canadian Takeovers: How Big Is the Problem?

The authors study the price--volume dynamics ahead of the first public announcement of a takeover for 420 Canadian firms from 1985 to 2002. Pre-bid price run-ups in a target firm's shares may be caused by some combination of information leakage due to illegal insider trading or market anticipation based on rumours in the press. The authors review empirical studies of illegal insider trading and trading ahead of unscheduled announcements to generate predictions for abnormal returns and abnormal volume ahead of the takeover announcement. They observe serially correlated volume and a pattern of return reversals in their sample. Pre-bid run-ups occur shortly before the actual announcement, accompanied by significantly positive abnormal returns and share volume. The stock prices of the target firm react significantly to the actual announcement, with both positive and negative reactions. These price–volume dynamics are more consistent with the predictions of the market anticipation hypothesis than the hypothesis of illegal insider trading.Financial markets

Prohibited Floor Trading Activities Under the Commodity Exchange Act

In algorithmic graph theory, a classic open question is to determine the complexity of the Maximum Independent Set problem on Pt -free graphs, that is, on graphs not containing any induced path on t vertices. So far, polynomial-time algorithms are known only for t≤5 (Lokshtanov et al., in: Proceedings of the twenty-fifth annual ACM-SIAM symposium on discrete algorithms, SODA 2014, Portland, OR, USA, January 5–7, 2014, pp 570–581, 2014), and an algorithm for t=6 announced recently (Grzesik et al. in Polynomial-time algorithm for maximum weight independent set on P6 -free graphs. CoRR, arXiv:1707.05491, 2017). Here we study the existence of subexponential-time algorithms for the problem: we show that for any t≥1 , there is an algorithm for Maximum Independent Set on Pt -free graphs whose running time is subexponential in the number of vertices. Even for the weighted version MWIS, the problem is solvable in 2O(tnlogn√) time on Pt -free graphs. For approximation of MIS in broom-free graphs, a similar time bound is proved. Scattered Set is the generalization of Maximum Independent Set where the vertices of the solution are required to be at distance at least d from each other. We give a complete characterization of those graphs H for which d-Scattered Set on H-free graphs can be solved in time subexponential in the size of the input (that is, in the number of vertices plus the number of edges): If every component of H is a path, then d-Scattered Set on H-free graphs with n vertices and m edges can be solved in time 2O(|V(H)|n+m√log(n+m)) , even if d is part of the input. Otherwise, assuming the Exponential-Time Hypothesis (ETH), there is no 2o(n+m) -time algorithm for d-Scattered Set for any fixed d≥3 on H-free graphs with n-vertices and m-edges

Executive stock option exercise with full and partial information on a drift change point

We analyse the optimal exercise of an executive stock option (ESO) written on a stock whose drift parameter falls to a lower value at a change point, an exponentially distributed random time independent of the Brownian motion driving the stock. Two agents, who do not trade the stock, have differing information on the change point, and seek to optimally exercise the option by maximising its discounted payoff under the physical measure. The first agent has full information, and observes the change point. The second agent has partial information and filters the change point from price observations. This scenario is designed to mimic the positions of two employees of varying seniority, a fully informed executive and a partially informed less senior employee, each of whom receives an ESO. The partial information scenario yields a model under the observation filtration $\widehat{\mathbb{F}}$ in which the stock drift becomes a diffusion driven by the innovations process, an $\widehat{\mathbb{F}}$-Brownian motion also driving the stock under $\widehat{\mathbb{F}}$, and the partial information optimal stopping value function has two spatial dimensions. We rigorously characterise the free boundary PDEs for both agents, establish shape and regularity properties of the associated optimal exercise boundaries, and prove the smooth pasting property in both information scenarios, exploiting some stochastic flow ideas to do so in the partial information case. We develop finite difference algorithms to numerically solve both agents' exercise and valuation problems and illustrate that the additional information of the fully informed agent can result in exercise patterns which exploit the information on the change point, lending credence to empirical studies which suggest that privileged information of bad news is a factor leading to early exercise of ESOs prior to poor stock price performance.Comment: 48 pages, final version, accepted for publication in SIAM Journal on Financial Mathematic

The interaction between informed and uninformed agents in securities markets

This dissertation contains three essays that examine the interaction between informed and uninformed parties in securities markets. Given the influential role that informed traders have in shaping securities prices, trading activity, market-wide and even economy wide outcomes, this research provides empirical evidence on significant and important issues. Each essay addresses a topical, yet under-developed research strand to ensure that the results of this dissertation are relevant to both academic and nonacademic parties. The conclusions drawn from the three essays have the potential to influence the decisions of fund managers, regulators, market designers and, direct and indirect investors in securities markets. The first essay examines the interaction between mutual fund managers and the investors that seek their services. Fund managers often incur significant adverse selection, transaction and opportunity costs when executing investors’ liquidity requests. Prior research hints that index futures are able to mitigate these costs, though no research has provided convincing empirical evidence, primarily due to the fact that existing data on fund managers’ use of derivatives is imprecise. Using unique survey data which indicates whether a fund manager uses index futures to manage investor flows or not, this essay is the first to provide conclusive empirical evidence on this issue. The results indicate that fund managers who trade index futures in this manner are unencumbered by investor flows and have superior fund flow conditional alpha and market timing measures of performance relative to their non-derivative trading peers. Informed fund managers are able to maintain their advantage even when their trading decisions are partially dictated by uninformed parties. The second essay in this dissertation examines the interaction between illegal insider traders and the regulatory body that prosecutes these individuals. Drawing upon insights developed in the literature which describes crime through the prism of economic thought, the essay develops a model which predicts the intensity of an illegal insider’s crime: their traded volume. The predictions of the model are tested using data drawn from case files of the Securities and Exchange Commission (SEC). As such, this essay is the first empirical study of illegal insider trading to investigate the behaviour of the insider, with all previous empirical research instead examining the market’s response to insider trading. The study hypothesises that insider volume is a function of two factors in control of the regulatory body and associated law makers: the expected return and expected penalty from the insiders’ trades. Furthermore, insider volume is hypothesised to be negatively related to the variance of the stock traded. The results, which validate the hypotheses and are robust to sample selection bias, have important policy implications for regulators seeking to detect illegal insider trading. While the first two essays consider specific examples of informed traders, the final essay in this dissertation examines informed traders in general. In particular, the study investigates whether broker anonymity in electronic order driven markets obscures the presence of informed traders during the lead up to a significant information event. This research is important given the prolific changes to this feature of market design in recent years across electronic exchanges globally, and the fact that all prior research in this area has yet to consider the effects of broker anonymity on information transmission during periods of large information asymmetry. The study presents three pieces of evidence that informed traders are better camouflaged when the identity of the broker intermediary is hidden vis-à-vis when the identity is visible. Naturally, this suggests that uninformed traders suffer at the expense of informed traders during the periods examined in this study. This finding has important policy implications for exchange officials deciding whether or not to reveal broker identifiers surrounding trades, especially considering that almost all prior research suggests that broker anonymity is correlated with improved liquidity in the form of lower bid-ask spreads

Capital markets and e-fraud: policy note and concept paper for future study

The technological dependency of securities exchanges on internet-based (IP) platforms has dramatically increased the industry's exposure to reputation, market, and operational risks. In addition, the convergence of several innovations in the market are adding stress to these systems. These innovations affect everything from software to system design and architecture. These include the use of XML (extensible markup language) as the industry IP language, STP or straight through processing of data, pervasive or diffuse computing and grid computing, as well as the increased use of Internet and wireless. The fraud is not new, rather, the magnitude and speed by which fraud can be committed has grown exponentially due to the convergence of once private networks on-line. It is imperative that senior management of securities markets and brokerage houses be properly informed of the negative externalities associated with e-brokerage and the possible critical points of failure that exist in today's digitized financial sector as they grow into tomorrow's exchanges. The overwhelming issue regarding e-finance is to determine the true level of understanding that senior management has about on-line platforms, including the inherent risks and the depth of the need to use it wisely. Kellermann and McNevin attempt to highlight the various risks that have been magnified by the increasing digitalization of processes within the brokerage arena and explain the need for concerted research and analysis of these as well as the profound consequences that may entail without proper planning. An effective legal, regulatory, and enforcement framework is essential for creating the right incentive structure for market participants. The legal and regulatory framework should focus on the improvement of internal monitoring of risks and vulnerabilities, greater information sharing about these risks and vulnerabilities, education and training on the care and use of these technologies, and better reporting of risks and responses. Public/private partnerships and collaborations also are needed to create an electronic commerce (e-commerce) environment that is safe and sound.Environmental Economics&Policies,Insurance&Risk Mitigation,Financial Intermediation,ICT Policy and Strategies,Banks&Banking Reform

Detecting and quantifying insider trading and stock manipulation in Asian markets

This paper focuses on insider trading, where the perpetrators exploit market sensitive information to earn profits or avoid losses. The paper's objectives are as follows. First, we seek to examine whether we can detect possible insider trading and stock manipulation and react in almost real time, even though insider trading activity is intended to be evasive. Second, we also estimate the extent of illicit profits (or loss avoidance) that might have been earned. Finally, we analyze, if detection is possible, the appropriate response for regulators and other market participants. We do not restrict our study to cases where corporate events have materialized, as we hope to capture insider trading surrounding market rumors and failed corporate events. Because insider trading is executed with the aim of being evasive and undetected, it is impossible to conclude with certainty. Nevertheless, using a hypothesized model based on how insiders and stock manipulators trade, we detect price patterns that are consistent with their objective to maximize profits and at the same time be evasive