Ba (Hons.) Dissertation

University of East Anglia | City
College Norwich

BA (Hons.) Business Management

Word Limit 10,000

A Comparison of Stock
Market Efficiency
between the US and
Emerging Markets
Dissertation

The purpose of this study is to test and compare the
efficiency of stock markets in emerging economies
compared with those in developed markets. If a stock
market is ‘efficient’, it is said that the price of a stock
reflects all information concerning a company’s
fundamentals (such as earnings reports, news of
mergers and acquisitions or pre dividend
announcements to name a few) weather such
information is available to the general public or has
yet to be released to the general public, or more
specifically, the shareholders.

A Comparison of Stock Market Efficiency between the US and Emerging Markets

Contents Page

Learning Outcomes 3

Summary 3

Literature Review 4

What are the Stock Markets 8

Three categories of market efficiency 9

Key Features of an Efficient Market 11

The Efficient Market Hypothesis 11

How do Efficient Markets Benefit Investors and Firms? 12

Definitions of Insider Trading 13

Who are Insider Traders 15

Typical Insider Trading Scenarios 16

Research Aim, 18

Methodology 19

Implications 19

Assumptions 21

Data Analysis: Observations 21

Conclusion 24

References 28

BA (Hons) Business Management | University of East Anglia Page 1


Learning Outcomes

Allows transferal of knowledge form a Literature Review to give a critical analysis to

the hypothesis/question of the study

Demonstrates independent reflection and initiative by applying the appropriate and

systematic research methodology to the problem of issue

Applies relevant concepts, theories, and evaluate techniques when analysing results in a

chosen area

Demonstrates the ability to draw defined conclusions from the research undertaken.

Summary

The purpose of this study is to test and compare the efficiency of stock markets in

emerging economies compared with those in developed markets. If a stock market is

‘efficient’, it is said that the price of a stock reflects all information concerning a

company’s fundamentals (such as earnings reports, news of mergers and acquisitions or

pre dividend announcements to name a few) weather such information is available to the

general public or has yet to be released to the general public, or more specifically, the

shareholders.

The focus of this study will be to determine that there may be a possibility, or not, of the

presence of insider trading taking place in emerging economies by testing to see if

investors within those stock markets achieve significantly abnormal returns compared with

the stock market average. This report will further explore the laws and regulations

currently in force in two economies: the United Stated and Mexico, of which have very



contrasting economics and wealth in terms of poverty and productivity, and to see how

well they actually work in deterring insider trading today.

Insider trading takes place where market participants are privy to and trade on information

which will not be released to the general public until a later date. This information will

have the power to move a stock price, such as a lawsuit or a profit announcement, and the

aim will be to generate large profits for the market participant if they trade on this

information. The aim of this study is to come to a conclusion as to how efficient the

markets in developed and less economically developed countries (L.E.D.C) countries are.

On a total of 103 countries which have stock markets resided in them, 87 of those nations

regulate insider trading activities but in varying degrees in terms of the severity of the

punishments and penalties that would follow when prosecution is brought before the law

(Bhattacharya &Daouk, 2000). The research of Bhattacharya &Daouk, (2000) concluded

that the regulation of insider trading appears to prevent those with information advantage

from trading at the expense of those who are not informed about such information.

The Standard Event Methodology, which is a widely used tool to test for various

characteristics in stock markets, will be applied here to, firstly, see if investors do react to

news broadcasts concerning the companies of which are being traded on the various stock

exchanged across the world: this is classed as the ‘null hypothesis’ or is otherwise known

as the ‘hypothesis of the status quo’, or if investors do not react to such information: this

will be classed as the alternative hypothesis. Secondly, the Event Study, as this is also

known as, will test to see if investors have achieved significantly abnormal returns by

measuring the difference between the expected returns (which is calculated using the

standard linear regression analysis) and the abnormal daily returns from the individual

shares, prior to such information being made public.



The right trading environment to trade on insider information is only when the markets

possess semi-form efficiency characteristics, and that financial managers have inside

information or knowledge, can the right environment be created for managers to gain

advantage and to exploit such insider information in order to realise excessive or abnormal

returns compared to the market average (ACCA, 2009).

Insider trading is not easy to estimate because people are reluctant to report it because of

the severe penalties in force if this was detected (Bris, 2005, p.269), and very few tests

outside of the US have been conducted at the time or writing, however, one research paper

was found on the Athens (www.athens.ac.uk) website which focused on the presence of

insider trading which was detected by applying the same event study, as this report will use

to test for insider trading in Mexico and the US, on the Istanbul Stock Exchange. The paper

was written by Dogu, Karacaer and Baha Karan, (2010) titled‘Empirical Testing of Insider

Trading in the Istanbul Stock Exchange’. Research carried out on the ISE concluded there

was evidence of insider trading present by showing that abnormal returns were achieved

ten days before the news release on a company which was listed on the exchange. This was

where buyers started purchasing stocks when the information in question was leaked to the

public. After the news was released, excess returns failed to break through the positive

boundary (Karacaer and Baha Karan, (2010).

Literature Review
Arguments for and against insider trading

The US has the strictest laws relating to insider trading, along with the UK and Canada,

where insider trading is strictly forbidden under Section 10(b) of the Securities Exchange

Act (1934), (SEC, 2012, Brody &Perri, 2011). The act goes even further by not only

addressing the corporate insiders on this act, but also to those who are known as



constructive insiders, and outsiders who are made insiders by a tip-off or through personal

or professional relationships. Constructive insiders are those who are informed by insiders

whom have a duty to keep such information personal until the time arises when this is

officially released into the public domain (Bris, 2005)

However, despite the enormous amount of legislation around insider trading, arguments

are still in fever pitch amongst scholars and practitioners whereby they argueon one side of

the coin that insider trading should be revoked, and on the other side (mainly the

regulators) state that insider trading is morally wrong, it deters investors and destabilizes

investments. It is not surprising then that this is the view of the Securities Exchanges

Commissionwhich is established to protect investors and maintain and fair and level

playing field in US-Domiciled money and capital markets (SEC, 2012).

A question of theft
Velasquez (2002) talks about the two main arguments against insider trading, stating that

insider trading is extremely harmful to the markets. Insider trading trades on information

which is stolen and that such information belongs to the corporation. Any asset that is used

by an insider for a gain, that gain morally belongs to the corporation it was taken from.

Georges, (1976) further elaborates on this by saying that preferential information belongs

to the company, so any exploitation of such privy information carried out by anyone other

than the company, this could be argued as theft.

A question of Fairness

The second argument questions the fairness of advantage of an insider having information

or knowledge over another investor. It is often the case that two parties do not have equal

knowledge when coming to a transaction because of the differing levels of due diligence

and analysis, however with insider trading, one member of that party has no way of



obtaining insider information regardless of how much research or due diligences has been

carried out on a particular stock prior to trading, unless that individual was in an extremely

privileged position or the moral or legal right to that information is questionable.

A further argument which Velasques, (2002) points out is of the effect insider trading has

on the market itself: it reduces the size of the market because investors are reluctant to

trade in a market which has high levels of insider trading. When fewer people trade in a

market, this leads to the markets being less efficient, more volatile and less liquid.

Arguments for insider trading are put forward by Block and McGee (1992) who state that

no individual has a moral obligation to disclose that a price will change once non-

disclosed information about a stock becomes disclosed. They also view that insider trading

is not fraudulent because there is no loss. This argument is supported by the mechanism of

buyers and sellers that if a buyer is buying stocks based on inside information a seller can

benefit from capital gains because the price is now pushed up from the buyers. However,

King &Roell, (1988) say that insider trading does create losses to the market makers who

will increase the spread, or the costs associated with trading the markets incurred by the

market participants, to maintain long-term profitability. This operates as a tax to market

participants and increases a disincentive to traders not to trade. This is also the main

argument of the regulators.

Further arguments against the practice of insider trading suggest that this discourages

investment as well as damaged corporate value due to non-insiders facing an adverse

selection problem, (Manove, 1989: Ausubel, 1990: Fischer, 1992). Furthermore, Brudney,

(1979): Easterbrook, (1985): Glosten, (1989):&Maug, (1995,2002), state that this

diminishes investor confidence and damages the integrity of the capital markets.



A point put forward by Bainbridge, (1988) states that the ban of insider trading reduces the

market’s efficiency as well as managers’ compensation. Manne (1966) supports this by

arguing that the prohibition of insider trading causes the stock markets to become less

efficient (based on the three varying degrees of efficiency as will be explained later on)

and the stock price will deviate from its fundamental value.

In a 2002 interview on CNN, Nobel Memorial Prize in Economicslaureate Friedman

Miller supports insider trading by stating that ‘you want more insider trading, not less and

wanting to give the people who are aware about any company deficiencies (insiders) an

incentive to make the public aware of this (by pricing this into the stock price), CNN,

(2002)

Arguments put forward by Carlton and Fischel, (1983): Dye, (1984) in support of insider

trading by saying that any restrictions should be revoked because this practice thus allows

private information to very quickly become incorporated into the stock pricing mechanism

which will ultimately lead to that stock becoming more informationally efficient.

There is also no violation of rights for non-insiders because they, again, achieve capital

gain from the rising price of the stock, making a profit, and so the act cannot be unjust.

They conclude that if the transaction is non-fraudulent and that if no-one’s rights have been

violated then there is nothing unethical about this practice. Insider trading has no victims

because any transactions carried out by the insider moves the stock price in the direction of

the preferential information and the counterpart will benefit from selling the stock at the

higher price and thus achieving a capital gain from the price increase.They also give a truer

reflection of the market price of a stock based on all information regardless of its public

availability – strong form efficiency- and also the opportunity to generate more capital

gains and income taxation for the economy, (Herzal& Katz, 1987)



Finnerty (1976) says that the regulation of insider trading exploits market efficiency as its

strongest form as the stock price reflects all information, preferential included and hence

the insider pushes the stock price faster towards a better reflection of the fundamentals of

the company.

Hague et al, (2004) stated that a key characteristic of Middle Eastern stock markets are that

they hold low liquidity, meaning less traders in the market. Bhattacharya et al (2000) also

says that emerging markets are the least efficient markets as they are prone to pre-

announcement leakages to market participants. When the news is released into the public

domain, this is already ‘priced in’ to the stock. However, this contradicts what others have

said about a market being weak-form efficient: in the ACCA (2009) it says that a weak

market’s prices only reflect past price movements where a strongly efficient market

reflects all past price movements and includes all publically available information as well

as insider information as well.

What are the Stock Markets?
Firstly, the stock markets, or more specifically a ‘market’ comprises of a mixture of buyers

and sellers of stocks, bonds, commodities and foreign exchange instruments whose price at

which those instruments are purchased and sold at being determined by supply and demand

forces, (Kahn, 2006). However, the prices are only determined by supply and demand

when there is a free market: that is, a market which is not influenced by government. Kahn,

(2006) goes further to explain the prime movers of such markets as:

The market is comprised of buyers and sellers

Price is determined by supply and demand

Supply and demand are determined by the aggressiveness of the bulls and bears



Bullish and bearish actions arise from perceptions of value

The market is a representation of all participants’ actions and perceptions of economic

forces of the companies within those stock markets and the economy as a whole. A

stock market chart is the graphical representation of such perceptions and actions

(Perception = reality).

The three categories of market efficiency

Market efficiency is categorised in terms of the characteristics they possess, these are:

weak-form efficiency – these apply to stock markets where the current price is reflected

by past price trends: Fama (1970) in fact states that all financial assets traded on a stock

exchange cannot be traded using information contained in the sequence of past prices.

Semi-strong form efficiency applies to markets where the current price is reflected by

past price trends and all publically available information. The strong form efficiency

theory applies to markets where the current price reflects past price movements, all

publically available information and private information as well. In other words, the

market is said to be efficient and ‘perfect’ when the price represents a fair and accurate

economic picture of a company by the company’s stock market valuation. It is also

important to note that, although efficient market pricing represents all available

information, it is about timing of the changes in price as new information becomes

available. This will create an imbalance of supply and demand of such shares as new

information becomes known to the public (ACCA, 2010)

Efficient market prices will change quickly to reflect new information where inefficient

markets will take a longer period of time to adjust to the new information as this gradually

becomes known and acted upon by different market participants through the course of time

or that the information has been leaked and acted upon prior to its official release (ACCA,



2010) This was evident in the research carried out on the Mexican and the US markets as

well.

To further illustrate this point, Yu, &Leistikow, (2011 pp.151-172) states that in a

‘perfectly efficient market’, traders and investors should not be able to make abnormal

positive returns using publically available information. Dimson and Mussavain (1998) say

that trading on available information through legit channels fails to provide an abnormal

profit.

Kahn (2006) sums up the existence of trends in an imperfect market resulting in uneven

information dissemination across all the market participants. The price movements in these

markets are the reason as to why traders trade the market: to take advantage of the price

movements and generate a profit.

Weak-form efficient markets – based on price movements solely – are traded by technical

analysis. This analysis is the opposite of a fundamental trader where information sources

from earnings reports, news broadcasts and annual reports are used to determine how a

business will fare in the future and therefore, weather to purchase a stock. Technical

analysis, Kahn (2006) puts forward the question of how traders can possibly rely on such

data which is subject to constant revisions. The role of technical analysis is to assess

current prices and where they are likely to go, based on past price movements governed by

the bulls and bears of the market (Kahn, 2006)

Levine (1997) states that a well-developed stock market promotes better economic growth,

better ability to attract higher international investment (capital inflows) and mobilize

domestic savings.



Key theoretical features of an efficient market

There are key features of an efficient marketplace and according to ACCA, (2010) these

key features, or characteristics of such efficiency are; the price of a security reflects all

information available in the public domain and that the share price will change quickly to

reflect newly released information, secondly, no individual dominates the market, investors

are rational, there are low or no costs to acquire information, and that transaction costs (or

spreads) are not so high as to discourage buyers and sellers from participating in the

markets. Dimson and Mussavain, (1998) state that if markets are sufficiency competitive

then investors cannot expect to achieve superior returns from their portfolios whilst

implementing their investment strategies.

Dimson and Mussavain, (2000) say that the term ‘efficiency’ describes a market which has

all relevant information reflected in the price of financial assets. This is an important point

to highlight because many economists use the term ‘efficiency’ when they refer to

‘operational efficiency’ which describes the way in which resources are used to facilitate

and operate the capital and money markets. For this research we will use the term

‘efficiency’ to illustrate how company information will be reflected into the price of a

stock.

The efficient market hypothesis (EMH)

The EMH applies where all prices react quickly to all available information and so

therefore investors cannot obtain higher than average returns from a well-diversified

portfolio. Dimson&Mussavian, (2000) further support this by stating that if capital markets

are sufficiently competitive, then investors cannot achieve superior profits from their

trading strategies. Fama (1976 p.113) talks about markets being efficient at processing new

information and that all prices will reflect all available information.



Kavussanos et al (2008) talks about perfect markets as those who price all new information

into their pricing mechanism simultaneously, however, lead-lag relationships, on the other

hand, exist when one market reacts faster to information than the other.

How does efficient market benefit investors and firms?

Because the stock market is efficient and, in theory, therefore investors will react in a

‘rational’ way, a firm investing in projects generating returns in excess of the minimum

required Net Present Value (NPV), the stock prices will adjust to this new information.

Investors will purchase its stock in anticipation of a rise in future profits and dividends (if

the firms pay dividends). The effect of this is the rise in the share price as a result of the

new imbalance of supply and demand; in this case demand exceeds supply which causes a

rise in share value, and reducing the firm’s chances of a hostile takeover (ACCA, 2010)

The current stock market price of the share is taken into consideration when calculating the

cost of equity as a percentage using the dividend growth model, which is in turn used as a

discount factor to apply to investment appraisals carried out by the firm when making

future investment decisions. This discount factor is used to discount against expected

future earnings and cash movements (ACCA, 2010)

The same applies if the opposite happens in that if the firm generates negative NPV’s from

their cash movements, its shareholders will be aware of this happening and so they will sell

the stock, therefore drive the stock price downwards and giving a fair stock market

valuation of that company because of the new imbalance of supply exceeding demand.

Market prices will also fall if interest rates increase because investors will want a higher

return on their investment (ACCA, 2010)



Definitions of Insider Trading

Insider trading is the trading of stocks and shares based on information of which is not yet

available to the general public, this is information which might influence the investors

decision to buy, hold or sell a stock based on weather this is positive, neutral or negative.

‘Insiders’ can come under a range of people in different occupations as market participants

or spectators. These can be company directors, investment managers, big shareholders or

company employees, brokers or analysts. So it is therefore obvious that these groups have

a monopoly over other investors which do not have such insider information, and if all

market participants could legally trade on such knowledge these would have a powerful

advantage of gaining excessive returns over the typical investor.

Misra, (2011, p 163) state that an individual would chose to indulge in inside trading to

generate profits or to avoid losses outside the normal rational decisions for buying and

selling securities based on publically available information. However this is only possible

with the possession of non-public, price sensitive information.

O’Hara (2001, p1047) stated that an insiders can be classed as any group or person that

gains such privileged information and comes under the categories of employees, managers

or directors of a company. Individuals can become insiders in a more intimate capacity

such as through family or friends, or close but external business associates. Also those who

have a contractual linkage such as suppliers (such as printers of company Annual and

Financial Statements) could be deemed to be insiders if they copy or withhold information

they were privileged to see or that they would see such information anyway in order to

conduct their job.

Haggerty and Fishman, (1995) state that insiders have also manipulated the markets by

announcing a piece of news, or several news items, to the public which has the potential to



move a stock price and therefore create opportunities for profit potential for upcoming

transactions.

The Financial Services Authority’s objective is to ensure that the stock markets are clean,

orderly and efficient. Although they do not believe that the UK markets have a high

activity of insider trading, they are also aware that there are a small handful of people

whom are prepared to act in an unlawful way when participating in the financial markets.

Insider trading raises costs to everybody else, increases volatility, and undermines

confidence. According to the FSA, (2011) financial institutions are required to submit their

transactions by the close of business on the next day after the transaction took place. This

enables the FSA to monitor and detect any possible market abuse activities from these

firms. For instance, firms are required to submit all transactions taking place on the

Monday by the close of business on the Tuesday. Failure to do this results in companies

paying very hefty fines! For example, the London-based spread-betting firm City Index

(www.cityindex.com) failed to submit approximately 55,000 transactions and reported

around 1,970,000 transactions incorrectly by errors in the relevant data fields. They were

fined £490,000, taking the 30% early settlement discount (FSA, 2011)

If the market is a public good, then the exploitation of insider information and having that

monopoly over other investors is damaging to the market itself. The enforcement of a ban

of insider trading increases confidence and trust in these markets which will encourage

investors to trade and maintain liquidity in such markets (Minenna, date not known)

In more recent times the FSA has become increasingly concerned with institutions’

abilities to exploit information of which they are legitimately entitled to for legitimate uses.

This has been evidenced from the work they have carried out over the years in monitoring

the markets with the aim of assessing market cleanliness. They have seen that stock prices



have risen before the announcement of an M&A which suggest that informed trading has

taken place.

A key area of focus is on the investment banks: more specifically the relationship between

these investment banks and their clients. This is the case because there is the risk that the

client can become an insider when he/she is made aware of an up and coming deal on a

particular company or stock.

Who are inside traders?

The Code of Market Conduct states than an insider is classed as a ‘regular user’ and is one

who is a ‘reasonable’ person who deals regularly with and has an intimate understanding of

how the financial markets operate. There is also a test for a ‘reasonable person’ which

employs similar techniques used in the English courts (Hu and Noe, 1997)

An individual or group can become an insider as a result of being in one or more

situations:

An individual as a result of their membership of the administrative, management or an

issuer of qualifying investments

As a result of holding capital of an issuer of prescribed investments

As a result of criminal activities

When an individual or group obtains information by other means such as a tip-off

from a friend or another individual who knows or could be reasonably expected to

know certain information which is not publically known, and that could potentially

change the share price.



Someone who has access to such information as a result of their employment, duties or

profession

To put this into a real-life situation there have been many cases where individuals and

companies have been prosecuted and sentenced for insider dealings. In 2010 five

individuals, including two former directors and a former senior trader employed by a

company called Blue Index Ltd, which was a specialist Contract for Differences (CFD)

firm, were charged with 17 counts of insider dealing. One was charged with three offences

of trading ahead of three separate takeover announcements, a former employee was

charged with one offence of trading ahead of one takeover announcement and a senior

trader was charged with offences of encouraging clients to trade CFD’s in relation to two

of the stocks. The advice to the client was given based on insider knowledge which was

not yet known to the general public (FSA, 2010)

A total of seven takeovers were traded ahead of their official announcement and the

individuals involved with insider dealings were sentenced contrary to section 52 of the

Criminal Justice Act. (FSA, 2010)

Typical scenarios of inside traders

A typical example of such an insider dealing is that of a pre announced merger. Mergers

usually means that the share price goes up once announced. However, shares purchased by

a director in anticipation that the share value will rise allowing him/her go achieve a capital

gains profit. Another example is that of a manager, who would naturally be privy to

information which was not yet released to their shareholders, of a mining and exploration

firm. They have found a new exploration site but news of this has not yet reached the

shareholders, the manager purchases shares in the knowledge that once that information



has been released the value of those shares will rise because of the purchasing power

enabled by the shareholders.

Bhattacharya et al (2000) stated that there has been evidence that emerging markets are the

most inefficient markets because they are most prone to information leakages prior to such

information officially being released. Bhattacharya et al (2000) also stated that the stock

markets in Mexico, as an example of this, did not react to corporate news, to which they

concluded the price had already fully adjusted to this news because it was leaked and

everyone traded on it, so there was no market reaction on the day of the official news

release. Fuentes and Maquieria (2001): Sultz (2005) and Guriev et al (2003) supported this

point in that other studies on emerging economies are prone to widespread insider trading

where insiders exploit their knowledge to obtain excessive returns. The aim of this study is

to prove or disprove this hypothesis.

In summary, if the markets are strongly efficient, then there is little point in the financial

manager trying to mislead the markets because:

The market will decide on the cost of capital (also known as the required rate of

return) and:

that the market will see when a firm is attempting to ‘window dresses their annual

accounts in order to place an optimal spin on the share price.

Other implications are that financial managers will be wasting their time in looking to

acquire companies which look undervalued in terms of their share capital because the

market will have ‘priced in’ all fundamental and technical information (depending on how

efficient the market is) about takeover target (ACCA, 2010)



Research: Implications, Aim and Methodology
Research Aim
This paper aims to come to a conclusion as to whether the stock markets (capital markets)

are as efficient as the USstock exchanges which are considered to be very efficient

compared to those of emerging markets.

The aim of this research is to determine the accuracy and question the literature

surrounding the topic of the presence of insider trading in emerging markets where it is

said the markets are less efficient and more prone to informational leakages. Furthermore,

this information will be used to measure the rate of abnormal returns made by investors if

they trade on inside information. The broad basis of this study is to test for possible

evidence of insider trading, which is trading on information prior to its official release.

This is a test to see if the buying and selling decisions yield abnormal returns and if this

provides a signal for other market participants.

A great deal of literature insists that insider trading is a significant barometer to broad

market shifts in sentiment. Very few studies have been conducted outside of the US but

Bhattacharya, (2000) states that the Mexican Stock Markets, as well as the US and the UK

markets have encountered abnormal returns from the buying and selling decisions carried

out by investors and it is the aim of this study to give support of Bhattacharya’s theories or

to disprove this.



Research Implications

Although there has been some ambiguity as to the exact definitions of the three types of

market efficiency the author will use the definitions of market efficiency taken from the

ACCA (2010) textbook.

Research Methodology

Data was collected on the adjusted closing prices of two companies listed on a stock

exchange from 2011-2012 as well as the adjusted closing prices of the corresponding stock

exchanges themselves. Any stocks where is has proven difficult or impossible to obtain

will be taken out of the sample.

If there is an association between market efficiency and market, we will then apply the

Standard Event Methodology to come to a reasonable conclusion as to which markets are

strongly efficiency and which are not. The study will be based on the Standard Event

Methodology Study, or an Event Study which averages the cumulative performance of

stocks overtime and will be based on the standard linear regression analysis formula y=mx

+ c in order to come to the expected daily returns from share (Ri). This will be measured

from a specified number of periods (days) before an event to a specified number of periods

after the news release.

For the purpose of this research, we will use the definitions taken the ACCA (2010

textbook for clarification on market efficiency.

Historical prices were obtained, for the study, from the ‘YahooFinance’ Service where it

posts the historical pricings for financial securities and their stock exchanges. These were

downloaded onto a spread sheet. A year’s worth of prices was obtained.



Two major news releases were then picked which fell into the time window of between 6th

May 2011 and 6th May 2012. For Apple Inc. the news release of the new iPad was selected

for the study (Apple. Inc, 2012). The release was on 7th March 2012. Cola Ferma posted a

6% profit increase in the fourth quarter of their financial year ending 29th February 2012

(Reuters, 2012). These news releases were placed on the excel sheet and a ten day window

was placed around the date of the news release.

The daily returns for each share, with a maximum holding time of 24 hourswas based on

the adjusted closing price for each day was then calculated using the following formula:

Daily Returns (D(r)) = (P1 – Po)/Po

The following was then calculated using the formulae available on Excel appliedthe prior

150 days before the 21 day event window (21 days being the ten days before the news

release, plus ten days after the news release, plus the day of the news release).

Intercept (=INTERCEPT)

Slope (=SLOPE)

R Squared (=RSQ)

Standard Error (=STEYX)

A table was then produced to calculate the following based on the 10 day event window.

The results are on the two tables taking up appendices one and two:

Er Expected Return INTERCEPT+SLOPE*MR
OR y = mx + c will return the same value
Ar Abnormal Return Ri – (y = mx + c) or Er
CAR Cumulative Abnormal Return CAR + AR
T-test Statistical Significance Test AR / SE

CCumulative Return


Standard Linear Regression Values
The values for the daily returns within (-150) window prior to the event window returned

the following values in Excel:

Apple Inc Coca-Cola
Slope (=SLOPE) 0.686767 -0.064201866
Intercept (=INTERCEPT) 0.002512 0.000727636
Standard Error (=STEYX) 0.014424 0.022132762

Assumptions

It has been assumed that the investment portfolios held by the market participants of both

stock markets have been diversified in such as way so that no unsystematic risk was a

feature in any portfolios. This means that the risks that such portfolios were carrying were

equal to the overall market risk, or what is known as the systematic risk, this cannot be

diversified away because this risk is determined by external economic pressures such as

interest rates and political events. Having an undiversified portfolio carries more risk and

therefore makes way for the possibility for abnormal returns which could affect the results

of the study that could show readings imitating the presence of insider trading when in fact

they are not.

Data Analysis

Observations

Looking at the data from Apple vs the NASDAQ, the presence of abnormal returns

compared to the expected returns from the share are relatively minimal before the news

release date and significantly negative at day (-2). In fact investors reacted very negatively



to the news this was released on day (0), however, upon further research it was revealed

that Korean-based Samsung, an electronics manufacturer, filed a lawsuit against Apple on

the same day on the basis ofcopyright infringement issues. This would have driven the

share price down, bearing in mind that these prices were calculated on the adjusted daily

closing prices which mean that these were the prices at the close of the trading sessions but

takes the average of the high, low and closing prices as well. However it was also observed

that there was a significant spike on ay (5) meaning that investors achieved large abnormal

returns compared to the market average.

One of two reasons for this: one could be that the news of Apples new product release

were realised by the market and thereby driving the share price upwards and giving a

signal to investors (thereby giving the markets an inefficient characteristic), or that some

insider information was released about the company concerning another important

announcement which would have the power to influence the investors’ decision to

purchase the stock and thereby creating an imbalance in the supply and demand of Apple

shares on the stock markets.

Large positive returns followed by negative spikes in the abnormal returns could be

associated with the volatility of the markets because large negative returns were generated

after the day (5). This was also the case on the chart which shows the expected returns

from the individual share versus the abnormal returns generated by those shares where

after the news release, large abnormal returns exceeded the expected returns with, again,

the large volatile peaks and troughs of the abnormal returns compared to the expected

returns of the share price swings.

Looking at both charts is evident that investors react to the information which invalidates

the null hypothesis because investors do, in fact, buy and sell stocks based on company



fundamentals broadcasted but in some cases not as much as in previous days. A lawsuit

would cause the markets to increase their volatility because there is uncertainty of how the

outcome will play as the judges will make their decision. Investors here were clearly

anticipating Apple having to pay out large sums of money in compensation to Samsung

over the copyright infringement, reducing Apples cash flows and, if investors are rational

(which is a characteristic of an efficient market), then they may well sell their shares as

was experienced in the negative abnormal returns generated on day (6).

Observing the Coca-Cola returns versus the Mexican Stock Exchange expected returns

where extremely wide volatile stings in the expected market returns. Market volatility is

associated with an inefficient market because of the fewer investors willing to trade on

such markets.

Looking at the charts it is very evident that investors did react to the news of their 28%

profit increase because there are significantly large spikes on day (2) but was slightly

delayed after the news release, which could give the markets in Mexico a slight

inefficiency in pricing in all available information.

However, like with Apple on the NASDAQ exchange, some insider information could

have been of another nature and so investors traded on this information by purchasing the

stock and giving a signal to investors, whom are not insiders, to do the same.

This would be a good point to mention that when looking back at the arguments for and

against insider trading, it was argued by Herzal& Katz, (1987), that insider trading is a

good thing because it not only prices all information about the company into its pricing

mechanism, but this gives a signal to other investors whom are not insiders to trade the

stock, by the use of technical indicators such as volume indicators, which, in increasing in

volume will mean that there is a bullish drive behind the price, will mean that a capital gain



can be achieved, therefore there is no loss and therefore no fraud is not committed. This

could be seen as the case with Coca-Cola and as with at day (2) abnormal returns in excess

of the market average were achieved.

Another possible cause for this would be that investors cannot achieve abnormal returns if

their investment portfolios’ unsystematic risk was equal to the systematic risk, in other

words, were as diversified as possible. So it could be assumed here that portfolios were not

as diversified as they could have been and so therefore, abnormal returns could have been

achieved here.

Conclusion

It remains inconclusive as to whether insider trading has taken place on the Mexican Stock

Exchange, prices certainly increased and thus generating a return to buy-side portfolios but

this can also be accounted for a range of other factors, such as another news release which

had more power to drive up the price of the stock, than the news release which we took

asas the focus of our study. Both news releases in general have the power to at least

influence an investors’ decision to purchase the stock: Apple released a new product and

therefore this would naturally be anticipated a profit increase from the sales generated by

the new product or even in anticipation of dividends, however there was no literature found

documenting Apple ever doing paying out dividends..

There is a similar story to CoCo-Cola in Mexico: a 6% profit increase means an increase in

company valuation, increased asset efficiency and return on capital employed, a relatively

low cost of capital due to an optimum capital structure, as well as the obvious: increased

sales are just a few factors which may determine an investor to act positively in terms of



the purchasing the stock and becoming a shareholder and owner of a relatively profitable

company when set against their industry averages.

A very large spike was observed on day (2) which may mean that the information took

longer to reach investors before they bought the stock. This means that the markets are not

as efficient as could be because it took a significant amount of time to give the company a

fair stock market valuation. They did react positively compared with the previous day

when negative excess returns were present.

The significant abnormal returns from Apple Inc. were achieved after the news release of

the New Generation iPad and before this; returns were relatively subdued in contrast. This

may indicate that insider trading is very minimal on the NASDAQ stock exchange, but

investors have reacted to the news, especially compared to the day before the news release

where there negative abnormal returns.

In summary, although there was evidence that only a small amount of insider trading

taking place on both stock exchanged, there is a more obvious theme here and that is the

time it took for news to reach investors: on both graphs there were significant spikes where

investors purchased the stock a few days after the news events were released and thus

giving the markets a low efficiency characteristic even though the price has reflected the

information that, by then, had been made public.

Another point to make is that there were spikes of insider trading prior to the news released

which supports Bhattacharya’s viewpoint of the Mexican Stock Exchange being a low

efficiency stock market in that the research presented here showed a very low reaction on

the day of the news release but a significant spike a few days before, and so this could have

been due to an information leakage to which investors acted upon and so the price was



already reflecting the news release when the news was announced and therefore making it

a ‘non-event’ as far and price movements were concerned.

Further Reading, Research and Development

This dissertation only looked at one company on one stock exchange in one developed

economy (the USA) and another one in a developing nation (Mexico). If one wishes to

develop a stronger case of evidence to support this very debatable and controversial topic

that is insider trading and the efficient market hypothesis, then a series of studies would

have to be competed in order to derive a varied range of companies, economies and stock

changes. Studying just one per economy is not enough.

This is because this makes room for any anomalies in the data and collecting additional

data will aid to determine which data is an anomaly and which aren’t when compared to a

range of examples. There have been very few studies of this nature outside of the USA and

so one could test a range of developing economies of which are outside of the USA. This is

mainly because such data has proven to be quite difficult to obtain in the past, however

with the invention of the internet more information than ever is at anyone’s fingertips

providing they have a laptop and a connection. Especially when studying the Middle

Eastern economies as it is against the Muslim religion to trading in these markets as this

constitutes a gambling and involves interest payments.

However, these studies could aid regulators to better understand what exactly is going on

in the markets domiciled in their countries, and because in some cultures there is a large

degree of bribery connected with the disclosing of insider trading, regulators can have a

better chance in changing the way in which the markets are facilitated and the resources

used.



Furthermore, it is possible that the dates which were used for the news released may not

have been the dates at which the news was actually released, and was in fact the date at

which the press release was written, which would affect the data. The dates were taken as

the dates mentioned on the news releases themselves, however, this may be a few days

before and which could explain the significant returns from the reaction of the investors a

few days before day (0) which would disprove that insider trading is taking place in both

Mexico and the USA.

Another factor which could be changed was the holding period. The holding period which

this research used was one day. However, longer holding periods could be analysed to

compare excess returns over different holding periods.



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Appendices (1)
The Expected Returns (Er), Abnormal Returns (Ar), the Cumulative Abnormal Returns

(CAR) and the Abnormal Return T-Test (ART-Test) for Apple Inc

Er Ar CAR ART-Test
-0.00048 -0.02716 -0.02716 -1.22728
0.001424 0.000496 -0.02667 0.022395
0.000336 -0.00134 -0.02801 -0.06055
0.000131 0.01165 -0.01636 0.526387
0.001678 -0.00746 -0.02381 -0.33683
-0.00089 -0.00547 -0.02928 -0.24701
0.002889 -0.00389 -0.03317 -0.17594
0.000807 -0.00145 -0.03462 -0.06537
0.000517 -0.0007 -0.03532 -0.03162
0.000334 -0.01196 -0.04728 -0.54035
0.000362 0.008344 -0.03894 0.376991
0.000235 0.001969 -0.03697 0.088967
0.00029 0.022156 -0.01481 1.001065
0.000267 -0.0224 -0.03721 -1.01207
0.000931 -0.00221 -0.03942 -0.10002
0.000549 0.000919 -0.03851 0.04151
0.002684 0.003821 -0.03468 0.172635
0.00023 0.001591 -0.03309 0.071873
-0.00255 -0.01281 -0.0459 -0.57862
0.002311 -0.01911 -0.06501 -0.86322
0.000246 0.005855 -0.05915 0.264528

SLOPE (M) 0.686767
INTERCEPT (C) 0.002512
STANDARD ERROR 0.014424



Appendices (2)
The Expected Returns (Er), Abnormal Returns (Ar), the Cumulative Abnormal Returns

(CAR) and the Abnormal Return T-Test (ART-Test) for Coca-Cola Mexico

Er Ar CAR ART-Test
-0.00107 -0.00244 -0.00244 -0.16924128
0.008087 -0.00156 -0.004 -0.10798504
0.004085 0.007573 0.003574 0.52502105
0.003071 0.003342 0.006916 0.2316697
0.007282 0.011072 0.017988 0.76761842
-0.00206 0.015186 0.033175 1.05284601
0.007623 -0.00388 0.029294 -0.269071
-0.00042 0.001728 0.031022 0.11979569
-0.00342 -0.01863 0.012394 -1.29140843
-0.00684 0.001396 0.01379 0.09678625
0.008499 -0.00769 0.006102 -0.53301124
0.010637 0.010656 0.016758 0.73875155
0.006656 -0.00079 0.015969 -0.0546546
0.001437 0.011091 0.027061 0.76893243
0.015453 0.013714 0.040774 0.95074054
0.002705 0.035106 0.07588 2.43380316
0.006045 -0.01286 0.063017 -0.89178278
0.002263 -0.00225 0.060771 -0.15570927
0.007696 0.018825 0.079596 1.30511107
0.001582 0.006503 0.086099 0.45083964
0.002774 -0.00848 0.077615 -0.58816368

SLOPE (M) -0.064201866
INTERCEPT (C) 0.000727636
STANDARD ERROR 0.022132762


Apple Returns vs The NASDAQ Market Average
0.04

0.03

0.02

0.01
Returns

Rm
Ar
0
-10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10

-0.01

-0.02

-0.03


0.06
Coca-Cola Abnormal Returns vs. Market Average

0.05

0.04

0.03

0.02

0.01 Rm
Ar
0
-10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10
-0.01

-0.02

-0.03

-0.04


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