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To analyze the relationship between information asymmetry and the returns generated when U.S. senators use political information to trade stocks, this review examines the study titled “A Dilemma of Self-interest vs Ethical Responsibilities in Political Insider Trading” by Jan Hanousek et al., published in the Journal of Business Ethics in October 2022. The study empirically investigates whether senators’ stock trades contradict social contract theory and explores the informational value of their transactions.

Methodology

This study is based on a dataset of 8,064 securities transactions, including 7,092 stock trades disclosed by U.S. senators under the STOCK Act between 2012 and 2019. To measure the information asymmetry associated with senators’ transactions, the study employs Abnormal Idiosyncratic Volatility (AIV), a metric that captures changes in stock volatility during specific events and is particularly suited for evaluating the likelihood of trades based on insider information.

Key Points of Methodology

• Abnormal Idiosyncratic Volatility (AIV): This measures the level of information asymmetry by analyzing volatility changes around trading days compared to normal periods.

• Event Window: A 5-day event window (2 days before and after the trade day, including the trade day) was used to calculate abnormal volatility and compare it with other periods.

• Focus: The study sought to determine whether senators’ trades generated higher AIV than major corporate events like quarterly earnings announcements or mergers and acquisitions (M&A), linking political insider information to stock returns.

AIV Calculation

1. Transaction Volatility (IVATT): Daily volatility during the 5-day event window was measured, excluding market-wide factors.

2. Non-Transaction Volatility (IVNAT): Volatility during other periods of the year was calculated similarly.

3. AIV: The difference between IVATT and IVNAT. A higher AIV indicates a greater likelihood that specific information influenced the stock on the transaction day.

The study confirmed that senators’ stock trades are associated with significant abnormal returns. Specifically:

• Stocks traded by senators recorded an average excess return of 4.9% over three months after the transaction date.

• As shown in the data, senators’ trades consistently outperformed the market over holding periods of 1 week, 2 weeks, 1 month, 2 months, and 3 months.

In terms of information asymmetry, senators’ trades recorded an average Abnormal Idiosyncratic Volatility (AIV) of 3.6%, which is three times higher than the 1.1% AIV observed during major corporate earnings announcements. This indicates that senators’ stock transactions are accompanied by significant information asymmetry.

Such asymmetry suggests that the political information held by senators carries substantial value in the stock market and demonstrates that senators participate in market transactions from a privileged position of informational advantage over other investors.

Conclusion

This study confirms that senators’ stock trades induce information asymmetry and exhibit a strong correlation with stock price volatility. Specifically, the timing of their transactions aligns with heightened AIV, indicating that the information senators use is indeed reflected in stock prices.

The existence of information asymmetry between U.S. politicians and the general public, coupled with the fact that senators achieve market-beating returns by holding stocks for three months after their purchases, suggests that trading based on senators’ political information could hold value as an investment strategy.

To explore the relationship between U.S. politicians’ stock purchase disclosures and stock returns, I reviewed the article titled “Perceptions of Political Self-Dealing? An Empirical Investigation of Market Returns Surrounding the Disclosure of Politician Stock Purchases,” published in the Strategic Management Journal in October 2022.

Hypotheses and Methodology

Hypothesis 1: The disclosure of stock purchases by senators will trigger a positive market reaction for the respective company’s stock.

Hypothesis 2: If a senator serves on a committee that oversees a specific company, the market reaction will be stronger.

Hypothesis 3a, 3b, 3c: When the company has lobbied on the senator’s legislation, testified in a committee where the senator serves, or has connections with the senator through campaign contributions, the market reaction to the senator’s stock purchase disclosure will be amplified.

Methodology

• Event Study and Cumulative Abnormal Return (CAR) Calculation: To measure the abnormal returns before and after the disclosure of senators’ stock purchases, they used the Fama-French 4-factor model to calculate CAR. They analyzed stock price changes across various event windows (e.g., disclosure day and the following day (0, +1), etc.).

• Cross-Sectional Regression Analysis: To examine the impact of variables such as committee membership, lobbying activities, and campaign contributions on market reactions, they conducted an OLS regression analysis.

• Information Asymmetry Check: To ensure that no information was leaked prior to the disclosure, they reviewed media coverage and conducted an additional event study for the actual purchase date.

Between 2012 and 2020, 2,234 instances of senators’ stock purchases were used as the sample for Hypothesis 1, and 2,066 instances were used as the sample for the other four hypotheses.

The above table shows the cumulative average abnormal returns (CAAR) analysis results for the impact of senators’ stock purchase disclosures on stock prices.

Both the equally-weighted index (where equal weights are given to each event) and the value-weighted index (considering each stock’s market capitalization) recorded positive CAAR across all four event windows. The standardized cross-sectional test and the generalized sign Z values also show statistically significant p-values, supporting Hypothesis 1 that the market reacts positively for a certain period after a senator’s purchase disclosure.

Table 2 reveals daily abnormal returns, capturing the stock price reaction before and after the senator’s stock purchase disclosures.

On the disclosure day, the equally-weighted and value-weighted abnormal returns were 0.09% and 0.11%, respectively, both statistically significant. Conversely, before the disclosure, abnormal returns were either negative (D-3, D-2) or positive but not statistically significant (D-1, p>0.1). Thus, Table 2 provides evidence for Hypothesis 1, showing a positive market reaction on the disclosure day and the days following it.

Finally, Table 3 uses cross-sectional analysis to examine the factors influencing abnormal returns following senators’ stock purchase disclosures.

This analysis uses Ordinary Least Squares (OLS) regression to understand how various factors affect stock prices when senators’ stock purchases are disclosed. Each coefficient in the table indicates the effect of independent variables on CAAR.

• Senator jurisdiction * lobbying the senator: When senators have lobbied for legislation benefiting a specific company, it has a significant positive impact on abnormal returns (coefficient 0.39, p = 0.02), supporting Hypothesis 3a.

• Senator committee jurisdiction: When a senator serves on a committee overseeing the company’s industry, abnormal returns increase significantly (coefficient 0.57, p = 0.01), supporting Hypothesis 2.

• Senator jurisdiction * campaign contributions: When companies make campaign contributions to senators, abnormal returns increase (coefficient 0.15, p = 0.02), indicating that campaign contributions may signal a positive relationship between the senator and the company, supporting Hypothesis 3c.

• Senator jurisdiction * congressional testimony: The coefficient for this variable is -0.36, but the p-value is 0.35, which is not statistically significant. Therefore, Hypothesis 3b is rejected.

Summary

In summary, this study identifies short-term profit opportunities following senators’ stock purchase disclosures. Additionally, analyzing the historical or current relationships between senators and companies, such as committee memberships or lobbying connections, may also reveal opportunities for abnormal returns.

Explore opportunities for generating abnormal returns by leveraging Waiker’s politician trading data.

Understanding market trends goes beyond price charts and economic indicators—sometimes, the most revealing signals come from within companies themselves. Insider trading data offers a unique lens into how corporate leaders view their own businesses, especially during times of market turbulence. In this article, we explore the relationship between the Insider Buy/Sell Ratio and the performance of the S&P 500 ETF (SPY), uncovering how insider behavior can serve as a powerful indicator of market sentiment and potential turning points.

The chart above showcases a comparative analysis of the Insider Buy/Sell Ratio and the performance of the S&P 500 ETF (SPY) over time.

Understanding the Buy/Sell Ratio

The Buy/Sell Ratio is calculated as follows.

1. Identify the number of stocks with positive insider net purchases (where net buy volume > 0) and compare it to the number of stocks with negative net purchases (where net buy volume < 0).

2. Divide the former by the latter and subtract 1, creating an indicator that captures insider trading behavior within the market.

This ratio is visualized as a time series on the primary y-axis (left), with markers and lines representing its trend.

Description

The chart clearly highlights key moments when the Buy/Sell Ratio spikes, coinciding with significant downturns in the broader stock market, as indicated by the S&P 500 ETF (SPY), plotted on the secondary y-axis (right).

During periods of substantial market decline, insiders appear to increase their buying activity relative to selling. This behavior likely reflects their confidence in the long-term value of their companies, suggesting that insiders perceive these periods as opportunities to accumulate shares at discounted prices.

Key Insights

1. Market Declines Trigger Insider Activity: Noticeable spikes in the Buy/Sell Ratio occur during major market sell-offs, such as the financial crisis of 2008, the COVID-19 crash in early 2020, and other correction phases. These spikes suggest that insiders may act contrarian to the broader market sentiment, buying heavily when prices drop.

2. Buy/Sell Ratio as a Contrarian Indicator: The trend indicates that the Buy/Sell Ratio could serve as a contrarian signal, potentially identifying periods of market pessimism where insiders foresee recovery or undervaluation.

Implications

This analysis underscores the potential predictive value of insider trading data. By tracking insider sentiment, market participants can gain insights into periods of heightened conviction among company insiders, particularly during market stress.

The synchronization of these two metrics provides a fascinating perspective on market dynamics and insider confidence, offering a valuable tool for traders, investors, and researchers seeking to understand market cycles.