Real-time Monitoring Of Insider Trading Under The Best Supervision

The insider trading regulation in reality is based on the real-time monitoring over the prices and other market characteristics. When the posterior probability of insider trading judged by the regulator according to these market variables exceeds a certain preset level, the investigation will be triggered. In such a situation, the probability of trigging an investigation is determined endogenously by the behavior of the insider. This article models the pattern of insider trading under such a kind of regulation, and derives the corresponding optimal regulation strategy.In case that there are no market professionals, the tighter the critical level of trigging the investigation, the less the expected losses of liquidity traders, and the lower the price efficiency. In case that there are some market professionals, the expected losses of liquidity traders fall first and then rise while the critical level is tightening, and thus an optimal level exists. The optimal level is loosing in the number of market professionals. When taking the survey cost of market professionals'and their entries and exits into account, the effects of the critical level on the expected losses of liquidity traders and the price efficiency are vague, depending on the survey cost and the success rate of the survey. In any case, the effectiveness of the regulation is always based on the realization of the penalty on the insider and the compensation of the victims.The results of the model have some implications for policy. The tightness of the critical level to trigger the investigation should change with the maturity of the securities industry. The more mature the industry is, the looser the level should be. In the early development of the industry, actions should be taken to create an atmosphere for the industry in which professional skills rather than illegal activities are favored, so that the number of legal analysts can rise steadily. At a certain point of time, the regulator should set tighter critical level for those individual securities of which the prices are more likely to change, or are likely to change more significantly, or of which the depth is larger ceteris paribus, or to which the analysts put less attention. In order to make the effect of regulation on the social welfare be positive, it is necessary to ensure the realization of penalty and compensation. The accurate refund can effectively reduce the distortion of the asset allocation resulted from the insider trading.