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Price Continuity Rules and Insider Trading

Prajit Kumar Dutta; Ananth Madhavan

Title:
Price Continuity Rules and Insider Trading
Author(s):
Dutta, Prajit Kumar
Madhavan, Ananth
Date:
Type:
Working papers
Department:
Economics
Permanent URL:
Series:
Department of Economics Discussion Papers
Part Number:
661
Publisher:
Department of Economics, Columbia University
Publisher Location:
New York
Abstract:
This paper analyzes the impact on price dynamics of price continuity-depth requirements that restrict transaction-to-transaction price changes when some traders possess private information about asset values. Price continuity rules enable insiders to slowly exploit their information over time. Paradoxically, more stringent price continuity requirements may actually improve market efficiency indirectly by increasing insider profits and inducing more traders to become informed at cost. We also demonstrate that the autocorrelation in returns induced by price-continuity rules provides a rationale for the use of technical trading rules by outsiders who effectively 'free-ride' off the private information of insiders. We show that price continuity requirements can make both insiders and outsiders better off by reducing the rents to market makers.
Subject(s):
Economics
Item views:
269
Metadata:
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