“Understanding Anomalies Using Insider Trading”
by Prof. Dr. Nejat Seyhun
Ph.D. in Finance, University of Rochester
Many studies show that future stock returns are predictable. These findings are consistent with either mispricing or risk. We use a large backward-extended insider trading database from 1975 to 2014 to construct anomaly-specific measures of mispricing that are designed to be unrelated to risk. We find mispricing is corrected shortly after insider trading becomes public when the direction of insider trading agrees with the anomaly. Mispricing completely disappears when the direction of insider trading disagrees with the anomaly, and mispricing is modest when there is no insider trading. We conclude that mispricing is an important component of the predictive ability of all thirteen anomalies we consider. Our evidence also indicates that insiders improve market efficiency through information not only about mispricing itself, but also about when mispricing will be corrected.