Knowledge that Transforms

Discussions about insider trading regulation veer between the poles of forbidding insider trading to protect market integrity and allowing insider trading to foster informational efficiency. We study traders’ preferences for regulation by offering them concurrent markets with different regulatory regimes in an experimental setting. We find that informed traders’ preference for the unregulated market causes both informed and uninformed traders to be more active in the unregulated market. This market, thus, sees more trading volume, lower spreads, and less mispricing. Nevertheless, uninformed traders suffer greater losses in unregulated markets, while informed traders profit from the absence of regulation.

I provide a new monthly cross-sectional measure of stock market tail risk, SCSTR, defined as the average of the daily cross-sectional tail risk, rather than the tail risk of the pooled daily returns within a month. Through simulations, I find that SCSTR better captures monthly tail risk rather than merely the tail risk on specific days within a month. In an extended period from 1964 until 2018, this difference is important in generating strong in- and out-of-sample predictability and performs better than the historical risk premium and other commonly-used predictors for short- and long-term horizons.

We extract an option-implied measure for systemic risk, the Systemic Options Value-at-Risk (SOVaR), from put option prices that can capture the buildup stage of systemic risk in the financial sector earlier than the standard systemic risk measures (SRMs). Our measure exhibits more timely early warning signals of main events around the global financial crisis than the main SRMs. SOVaR shows significant predictive power for macroeconomic downturns as well as future recessions up to one year ahead. Our results are robust to various specifications, breakdowns of financial sectors, and controlling for other main risk measures proposed in the literature.