Intervention for your own good

Insider trading feels unfair, but increases the efficiency of financial markets. A price should reflect an estimate of the future profitability of the underlying asset, and insider trading allows those with the most information to have more of an impact on that price.

The Supreme Court is currently considering a case that will determine how broadly to define insider trading. If the defendant loses, then cases where a family member of an insider benefits from a stock tip could be considered insider trading. If he wins, it will probably be much more difficult to prevent insider trading. But why should we?

Some argue that the possibility of insider trading creates a problem of asymmetric practicable information–insiders always know more, but if they’re allowed to act on that information, outside investors lose incentive to invest in potentially valuable projects. That may be, but does it justify prohibiting insider trading? No.

The problem of asymmetric information requires a commitment device, but that device doesn’t have to be one-size fits all. Let businesses and investors solve this problem themselves with contracts.

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5 thoughts on “Intervention for your own good

  1. I’ll apologize in advance for the oddball question. I’m sorry.

    My interpretation of what you’re saying is that people with access to information not available to others [i.e. the asymmetric information] have property rights over that information. However I seem to recall several instances here where libertarians were reluctant acknowledge intellectual property as property. How would the different strands of libertarian thought come down on the question of asymmetric information as property?

    • Under current rules, certain behaviors are forbidden. Alternative rules may or may not increase people’s well being. But a rule that didn’t forbid this particular behavior need not prevent people from finding a way to improve their well-being through alternative means. If private solutions are cheap, easy, simple, and likely compared to the public solution, then privatizing is a no-brainer.

      Essentially the economic argument for prohibiting insider trading is that insider traders myopic behavior could reduce investment and thus long-term growth. Prohibiting insider trading serves to manage the commons… instead of taking advantage of investors for short-run gain, entrepreneurs will be credibly committed to honest dealings that are in their own self-interest. But that doesn’t mean that entrepreneurs are doomed to myopic behavior. They could sign contracts specifying the conditions under which they may sell their own shares, etc. In essence, insider trading prohibition is financial paternalism for the insiders.

      The intellectual property rights question is taking my mind in a bunch of interesting places, but exploring them would stretch my comment over multiple pages. I’ll just leave it at this: scarce valuable knowledge is (and always will be) the object of exchange.

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