Insider Trading: Regulation, Risk Reallocation, and Welfare

I argue in this article that the imposition of insider trading regulation on a securities market generates not only a reallocation of wealth from insiders to liquidity traders, but also a reallocation of risk from the former to the latter. I show that this reallocation of risk (usually ignored in the literature), unlike the reallocation of wealth (usually addressed in the literature), has a critical impact on social welfare. I further show that, under some assumptions, this risk reallocation imposes a cost on society. * I would like to thank Ignacio Peña, Asani Sarkar, participants of the First Conference in Law and Economics at Carlos III University (Madrid, Spain), and participants of the Gerzensee Conference on Regulation and Risk in the Financial Services Area (Gerzensee, Switzerland) for helpful comments and suggestions. The views expressed below and any errors that may remain are entirely my own. ** Universidad Carlos III / Departamento de Empresa / 28903 Getafe, Madrid. SPAIN TEL: (34-1) 624-9578 / FAX: (34-1) 624-9875 / EMAIL: [email protected]