Ebook Investigation of Market Efficiency: An Event Study of Insider Trading in the Stock Exchange of Hong Kong
Most developed countries around the world have enacted laws prohibiting insiders from trading based on non-public information in order to establish a market environment where security trading is a fair game for all participants. However, the numerous empirical analyses that have focused on insider trading have consistently documented that portfolios which are constructed on the basis of the trading behavior of insiders generate abnormal profits. These abnormal profits, which are the result of insider’s prior access to knowledge about public information events, indicate the existence of an inefficient market.
In an efficient market all available information relevant to the pricing of securities must be rapidly reflected in the prices of the securities. The arguments of Fama (1965) form the theoretical foundation for the Efficient Market Hypothesis, which persuasively reasons that in an efficient and active market consisting of many well informed investors, equity prices will appropriately reflect the effects of information based on present and future expected events. The strong form of the hypothesis asserts that the current market prices fully reflect all private (insider) and public information. In other words, insiders should not be able to earn excess returns from privileged asymmetric information. The strong form of the hypothesis represents an absolute standard, and in practice, it is more likely that markets will exhibit only a certain degree of efficiency.
The previous studies on insider trading display the ability of insiders to make abnormal profits, thus refuting the strong form of the Efficient Market Hypothesis. Among these prior efforts, however, the majority have primarily focused on U.S. capital markets, and thus, their conclusions may not be applicable to security markets in other parts of the world. In addition, very little research of the same nature has been conducted on Asian markets, especially the financial markets of Hong Kong. Accordingly, this paper seeks to fill this gap by focusing on the Stock Exchange of Hong Kong (SEHK).
Although the SEHK is the largest stock market in Asia outside Japan with a market capitalization in excess of USD615 billion (Fact Book 2000), it has received very little scholarly attention to date. It is thus the primary purpose of this paper to examine the efficiency of the Hong Kong stock market by using an event study approach to investigate the abnormal price and volume performance surrounding corporate news announcements of firms listed on the SEHK. More specifically, I aim to test for the existence of significant abnormal changes in equity prices and volumes that take place prior to, during, and after homogeneous news announcements. Since changes in equity prices must fully reflect all new available information in an efficient market, any changes prior to a news release directly suggest the existence of insiders taking advantage of their possession of private information and, or,information lea kage by insiders, and thus signal a dishonest market.
This is an aspect of the securities market environment to which the securities data of both Hong Kong and the U.S. have not been systematically applied. Most prior studies make use solely of the data surrounding the insider trade transaction dates, which are published monthly by their respective securities commissions, and test for abnormal profits around those transactions periods. Such an approach might not reveal illegal insider trading that is intentionally not reported to the securities commissions and that abuses non-public information. I take a different approach by directly examining the relationship between public announcements of corporate news and abnormal changes in prices and volume. Such an examination of stock price and trade volume behavior over the pre- and post- announcement periods might provide a clear indication of whether insiders do indeed trade on unreleased information.
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