In America, the Securities and Exchange Commission (SEC) has really cracked down on illegal insider trading by making several high-profile arrests and launching some rather extensive investigations. Now three social scientists have decided to look into a solution to illegal insider trading.
Henk Berkman at the University of Auckland, Paul Koch at the University of Kansas and Joakim Westerholm at the University of Sydney have released a new study accepted for publication in the Journal of Finance where they have uncovered a new way to spot insider trading.
The men researched over half a million stock market accounts in Finland from 1995 to 2010 on the Helsinki Exchange. The researchers chose Finland because it offered them unusual and extensive access to information about trades as well as information about individual investors.
The researchers looked at the information in many different ways including investors’ personal information like their age. As the researchers were analyzing the data according to the age of the investor they found that the accounts belonging to young children did astonishingly better than any other age group.
“We were very surprised when we first found this evidence,” Paul Koch said. “Again, we were not looking for the result we found. The group [of accounts belonging to children between the ages of zero and 10 years old] seemed to outperform all the others.”
Clearly Koch isn’t saying that a bunch of toddlers know how to make the right picks in the stock market, but their parents do. The people who operated these children’s accounts were their parents and guardians.
Koch went on to report, “We find that underage account holders exhibit superior stock-picking skills on both the buy side and the sell side over the days immediately following trades. Accounts belonging to children (and managed by their guardians) appeared to be especially prescient when it came to major company events such as merger or takeover announcements."
Typically when a company announces a takeover or merger it typically initiates a large fluctuation in the stock market prices. The researchers discovered that the adults made the right decision about 50% of the time before a takeover announcement.
But in an unexpected discovery, the researchers found that the accounts belonging to the children made the correct decision in buying and selling 72% of the time after takeover announcements. (They noted that this isn’t 12% per year; it’s 12% per day.) As the researchers furthered their investigation they found that the parents of these children didn’t do nearly as well in their own holdings.
“Guardians are willing to trade on behalf of their children to earn these extraordinary returns, but they are reticent to trade through their own account,” Koch says. “One reason would be a fear of getting caught breaking an insider-trading law.”
Koch went on to explain that the results implied that regulators like the SEC who want to track insider trading might pay attention to successful accounts belonging to children.
When Koch was asked whether his findings from Finland were applicable to U.S. insider trading cases, he said that they were. Koch explained that the information would not be as easy to access as it was in Finland but that the SEC definitely has access to the information.
To listen to Paul Koch’s entire interview with Shankar Vedantam on NPR, click here.