Insider Trading with Penalties

Sylvain Carré (), P. Collin-Dufresne and Franck Gabriel
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Sylvain Carré: Institut de Recherche pour le Développement (IRD), LEDa - Laboratoire d'Economie de Dauphine - IRD - Institut de Recherche pour le Développement - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres - CNRS - Centre National de la Recherche Scientifique
P. Collin-Dufresne: Swiss Finance Institute [Lausanne] - EPFL - Ecole Polytechnique Fédérale de Lausanne
Franck Gabriel: Département de Mathématiques - EPFL - EPFL - Ecole Polytechnique Fédérale de Lausanne

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Abstract: We consider a Kyle (1985) one-period model where insider trading may be subject to a penalty that is increasing in trade size. We characterize the solution - the equilibrium price and optimal trading strategy - explicitly and establish existence and uniqueness for an arbitrary penalty function for the case of uniformly distributed noise. We use this framework to capture the difference between legal and illegal insider trading, and identify the set of ‘efficient penalty functions' that would be optimal for a regulator that seeks to minimize expected uninformed traders' losses for a given level of price informativeness. Simple policies consisting of a fixed penalty upon nonzero trades belong to this set and can be used to implement any efficient outcome. Using numerical analysis, we show the robustness of our results to different distributional assumptions.

Keywords: Kyle model; Non-linear equilibria; Market microstructure; Insider trading; Market regulation; Efficient penalties (search for similar items in EconPapers)
Date: 2022-07
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Citations: View citations in EconPapers (5)

Published in Journal of Economic Theory, 2022, 203

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-03689743

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