Thursday, November 10, 2011

Insider trading by Congress?

An article earlier this year by a Georgia State University researcher and colleagues in the electronic journal, Business and Politics, uncovered evidence that suggests that Congressional representatives may have been financially benefiting from insider information.
We measure abnormal returns for more than 16,000 common stock transactions made by approximately 300 House delegates from 1985 to 2001. Consistent with the study of Senatorial trading activity, we find stocks purchased by Representatives also earn significant positive abnormal returns (albeit considerably smaller returns). A portfolio that mimics the purchases of House Members beats the market by 55 basis points per month (approximately 6% annually).
As the blurb indicates, the study produced results that were consistent with an earlier analysis of Senators' stock returns, and some of you may recall an earlier insider financial transaction by a panicked Sen. Burr.

The evidence from the latest study is suggestive but far from convincing. First, the evidence is indirect; the authors don't examine insider trading directly but instead try to infer it from stock returns.

Second, the study includes evidence that counters the insider trading argument. For example, the authors found that stock returns were high for junior members of Congress but not for senior members. To the extent that insider knowledge and influence increase with seniority, we might expect the opposite relationship to hold.