Three Essays in Insider Trading.

Abstract

This dissertation investigates insider trading around significant corporate information events.

Chapter 1 tests the prediction of standard option pricing models that there is no relation between past stock returns and stock option prices. Using individual stock options data, we show that puts are significantly overvalued relative to calls after large stock price increases and calls are significantly overvalued after large stock price decreases. This is exactly opposite to what we have observed in index options. We argue that it is the autocorrelation structure of the individual stock returns that drives this valuation effect, which areboth economically and statistically significant. Overall, our results suggest that past stock returns exert an important influence on individual stock option prices.

Chapter 2 investigates trading volume and profitability of insider trades around scheduled versus unscheduled corporate announcements to explore how corporate insiders utilize their private information when there is dispersion in the amount of liquidity trading. I show that corporate insiders trade more heavily before unscheduled corporate announcements as compared to scheduled announcements. Also insider trades before unscheduled announcements are much more profitable than those before scheduled announcements. This evidence clearly suggests that corporate insiders time their trades around material corporate information events based on the amount of liquidity trading available to camouflage their trades. I also relate this finding to private information and test whether PIN captures information asymmetry around such events. I find that PIN is much higher before unscheduled announcements than before scheduled ones.

Chapter 3 examines option trading before significant information events. Using a broad sample of merger announcements, I find that there is abnormal option trading prior to such announcements after controlling for merger characteristics. This abnormal option trading is mainly concentrated in short-term and at-the-money options. Trading volume in these options leads stock market order imbalances and strongly contributes to the pre-takeover stock price runup. Implied volatility spread calculated from these options is strongly positively associated with the abnormal option volume. Finally, I also investigate whether option volume can be used to predict takeover targets. I find strong predictive power of option volume for takeover targets.