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Information‐Hedging Disclosures and Insider Trading
Author(s) -
Lenkey Stephen L.
Publication year - 2016
Publication title -
journal of business finance and accounting
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.282
H-Index - 77
eISSN - 1468-5957
pISSN - 0306-686X
DOI - 10.1111/jbfa.12224
Subject(s) - insider trading , insider , market liquidity , business , adverse selection , factor analysis of information risk , information asymmetry , economics , actuarial science , monetary economics , financial economics , microeconomics , risk management information systems , finance , information system , management information systems , electrical engineering , engineering , political science , law
I model the effect of disclosure on the tradeoff between information risk, liquidity risk, and price risk for a well‐informed, risk‐averse insider. Revealing some information before trading decreases the variability of the insider's information advantage and thus reduces his information risk. Disclosure also lowers adverse selection costs for market makers, which reduces the insider's liquidity risk by increasing his trading flexibility. However, disclosure increases price risk for the insider because the price fully reflects the revealed information. The reduction in information and liquidity risks outweigh the rise in price risk when the insider is less risk averse because a less risk‐averse insider's information‐based motive for trading is stronger than his hedging motive. The opposite relation holds when the insider is more risk averse. Therefore, a less (more) risk‐averse insider experiences an increase (decrease) in welfare when he discloses some information before trading. Cost of capital and policy implications are identified.