When chasing the offender hurts the victim: The case of insider legislation

Abstract

Backers and opponents argue over the pros and cons of legislation forbidding trading by informed insiders. Yet a lack of reliable empirical data about the effects of such legislation inhibits a conclusive scientific evaluation. We overcome this problem by resorting to laboratory markets and find that insider legislation has significant negative effects on multiple market dimensions: under insider legislation, (1) markets are less liquid, (2) markets are less informationally efficient, and (3) uninformed traders׳ earnings (before redistribution of illicit insider gains) are lower.

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