An Empirical Analysis of Legal Insider Trading in India

Abstract

The motive of this research is to examine the insider trading behavior in the Indian stock market and to determine the profitability and information content of insider trading. It also aims to investigate the relationship between insider trading and stock market crashes. The empirical study is based on disclosures made under SEBI (Prohibition of Insider Trading) Regulations, 1992 to Bombay Stock Exchange (BSE), which comprises the insider transactions of all the listed companies of BSE from April 2007 to March 2015. The study uses the four-factor asset pricing model that adjusts for size, book to market and momentum factors and event study methodology. The empirical results confirm that insiders seem to have a preference for large market capitalization companies, companies with low BE/ME ratio, high momentum, and low P/E ratio. The analysis of abnormal returns to insider trading strategies shows that insider purchase portfolios earn positive abnormal return and sale portfolios earn negative abnormal return. However, outsider group does not earn significant abnormal return during the same period. The results also show that insider purchase as well as sale portfolios earn positive abnormal return in the pre-event window, whereas purchase portfolio earns positive abnormal return and sale portfolio earns negative abnormal return in the post-event window. Insider purchase and sales over a year‟s time play a major role in causing stock market jump and crash respectively. Insiders trading activity diminishes substantially just ahead of the crash or rally, whereas outsiders trading activity increases just ahead of crash of rally. The findings of the present study substantially exceed the previously documented degree of predictability of insider trading.