Measuring the Incidence of Insider Trading in a Market for State-Contingent Claims

Hyun Song Shin

Economic Journal, 1993, vol. 103, issue 420, 1141-53

Abstract: Even in competitive financial markets, the presence of insider traders leads to a divergence between the selling and buying price, as intermediaries attempt to recoup their losses to the insiders by extracting a margin from other traders. The extent of this divergence is an indication of the severity of the market distortion due to insider trading. Conversely, the incidence of insider trading may be inferred from observed spreads given an appropriate model of trading. In this paper, the market for bets in a horse race in which bookmakers set prices serves as the vehicle for such an investigation. By solving for the equilibrium prices in a game in which bookmakers compete in prices, the market spread is obtained as a function of the incidence of insider trading and other parameters. this incidence is then estimated from U.K. data. Copyright 1993 by Royal Economic Society.

Date: 1993
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