INSIDER TRADING, REGULATION, AND THE COMPONENTS OF THE BID–ASK SPREAD

Authors


  • The authors would like to gratefully acknowledge the helpful and constructive comments from the referee, Jenifer Koski, and the editor of the journal, Jayant R. Kale, on earlier versions of this article. They also would like to acknowledge the comments from the participants at the 10th New Zealand Finance Colloquium, Dunedin, New Zealand (2006); the 19th Australasian Banking and Finance Conference, Sydney, Australia (2006); the Financial Management Association (FMA) Meetings Europe, Stockholm, Sweden (2006); and FMA/Asian Finance, Auckland, New Zealand (2006). Any remaining errors are ours.

Abstract

In this article we investigate the relation between insider trading regulations and the bid–ask spread. We decompose the spread into its components before and after the enactment of strict new insider trading rules in New Zealand. We find that the enactment led to a significant decrease in the information asymmetry component of the spread, which is observed mainly in illiquid and high prechange information asymmetry companies. These findings are robust to model specification. In addition, we find a decrease in the contribution of information asymmetry to price volatility.

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