Insider Trading via Sell-Side Analysts? Welcome to the Jungle!

Insider Trading via Sell-Side Analysts? Welcome to the Jungle!

March 20, 2013 Research Insights
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(Last Updated On: January 13, 2017)

Tipping

  • Paul Irvine, Marc Lipson, and Andy Puckett
  • A version of the paper can be found here.
  • Want a summary of academic papers with alpha? Check out our free Academic Alpha Database!

Abstract:

This paper investigates the trading behavior of institutional investors immediately prior to the release of analysts’ initial buy and strong buy recommendations. Using a proprietary database of institutional trading activity from the Plexus Group, we document abnormally high trading volume and abnormally large buying imbalances beginning five days before initial recommendations are publicly released. Furthermore, abnormal buying activity is positively related to initiation characteristics associated with greater abnormal price responses, including some that would require knowledge of the content of the report – such as the identity of the analyst and whether the recommendation is a strong buy. We confirm that institutions buying prior to the recommendation release earn positive abnormal trading profits. Taken together, our results suggest that some institutional traders receive tips regarding the contents of forthcoming analysts’ reports. To the extent that brokerage firm clients who benefit from these tips are more likely to direct business to the initiating brokerage firm, tipping provides economic profits to the brokerage that can help defray the cost of analyst information gathering. Thus, while tipping benefits some traders at the expense of others, the welfare consequences of tipping are unclear.

Data Sources:

Plexus Group, IBES, CRSP/Compustat.

Alpha Highlight:

tipping
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Strategy Summary:

  1. Don’t listen to sell side research.
  2. Make Don’t lose money.

Commentary:

  • Avoid people who own yachts and fancy cars.

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About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.