Insider Trading Returns Calculated by Josef Lakonishok and Inmoo Lee

insider trading returns Inmoo LeeInsider trading has been a very attractive research area for the past 50 years. It used to be that when a study analyzed returns to insider trading, only small data samples were used. The use of computers to help with the analysis didn’t come until later. One of the first studies that used the entire insider trading dataset was Josef Lakonishok and Inmoo Lee’s 2001 Review of Financial Studies paper. Korea born Inmoo Lee received his Ph.D. in 1995 from the University of Illinois at Urbana-Champaign. There, he became a student of behavioral finance icon Josef Lakonishok. Lee tried his hand in academia, but later decided to be a quant at Eugene Fama’s Dimensional Fund Advisors. Apparently being a student of Lakonishok’s didn’t hinder his chances at getting the Vice President of Research position at the “Efficient Markets Hypothesis” shop.

Josef Lakonishok has been doing behavioral finance research for more than 30 years. He is the second largest owner of LSV Asset Management. He is quite successful too, making tens of millions of dollars ever year. For more information about Lakonishok’s fund management experience, you can read our article titled Best Mutual Funds: LSV Value Equity Fund Returns and Alpha.

Lakonishok and Lee analyzed insider trading returns (see definition of insider trading) using all companies from 1975-1995. They also investigated aggregate insider trading as a signal for the direction of stock market indexes. Interestingly, aggregate insider trading can be used to predict the movements of stock market indexes. They calculated the ratio of purchases minus sales to total insider transactions for each month and then compared that ratio with the 59 other monthly ratios over the last 5 years. When the net purchase ratio was in the top quintile, that meant insiders were the most optimistic. Lakonishok and Lee found that the stock market increased an average 21.2% during the following 12 months when insiders were most optimistic. Whenthe net purchase ratio was in the bottom quintile, that meant insiders were the most pessimistic. The pair found that the stock market returned an average 8.1% during the following 12 month period. It’s clear from this study that aggregate insider trading has some signaling power about the future direction of stock market.

Also in the study, Lakonishok and Lee found that firms with extensive insider purchases beat firms with extensive insider sales by 7.8% during the following 12 months. However, insider purchases are tilted towards small and high book-to-market companies whereas insider sales are tilted towards bigger and low book-to-market companies. That relationship affect the returns favorably. When we control for size and book-to-market effects, the abnormal returns drop to a still respectable 4.8%.

The other takeaway from Lakonishok and Lee’s study is that insider trading is more informative in smaller firms. As a result, investment strategies developed based on insider trading can manage small amounts (hundreds of millions instead of billions) profitably.

Related Topics:
Is Insider Trading Legal?
How Insiders Use Private Information and Don’t Get Caught?
SEC Regulation on Insider Trading: Section 10b

Comments
Insider Monkey Small Cap Strategy
Insider Monkey Small Cap Strategy

Insider Monkey beat the market by 52 percentage points in 24 months. Our beta is only 1.2 (don't click this link if beating the market isn't important to you).

Lists

Cheapest Cities to Visit in the US

Most Expensive Summer Camps

Most Expensive Animals in the World

Most Expensive Specialty Crops in the World

Movies That Took Ages to Make

The Longest Hollywood Films Ever Made

Most Expensive Concert Stages

The Richest Bands of all Time

10 Most Corrupt Countries 2013 List

10 Countries with the Highest Quality of Life Index

Most Expensive Mattresses in the World

5 Smallest Countries by Land Area

The Ultimate Heartbreak Songs

Richest Teenagers in the World

10 Most Haunted Places in America

10 Best Places to Retire in Florida East Coast

Top 10 Places to See Before You Die

Top 8 Countries in the World Where Justice Prevails

10 Richest States in America

15 Wealthiest Countries in the World

Richest Singers in the World

Most Expensive Tasting Menu in New York City

Most Expensive Baby Items in the World

Most Expensive Hotel Suites in Vegas

Most Expensive Brunch in New York City

Most Expensive Beef Cuts in the World

25 Best Colleges to Get a Job

Top 10 US Supermarkets

The 25 Most Dangerous Cities in the World to Visit

Most Expensive Xbox Games

Top 11 Cities Where Billionaires Live

Top 10 Most Charitable Companies in America

Most Expensive Seafood in the World

The 10 Wildest Conspiracy Theories

The 10 Best Job Markets in the US

Top 10 Accounting Scandals of All Time

The 25 Biggest Cities in the World

Top 10 Best Paying Virtual Jobs

Most Expensive Leather Shoes in the World

Top 6 Things to Buy in March

The 10 Most Stressful Jobs in America – 2014 List

Top 10 Jobs for Introverted People

Top 10 Honeymoon Destinations in the World

Top 10 Highest Paying Jobs in the World

Most Expensive Day-Care in New York City

The 10 Cheapest Places to Retire Abroad

Top 10 Most Expensive Luxury Cars in the World – 2014

Killer Small Business Ideas

The 50 Best Personal Finance Blogs

Most Expensive Apartments in New York City

Subscribe

Enter your email:

Delivered by FeedBurner

X

Thanks! An email with instructions is sent to !

Your email already exists in our database. Click here to go to your subscriptions

Insider Monkey returned 47.6% in its first year! Wondering How?

Download a complete edition of our newsletter for free!