Insider Trading when Markets are Irrational: Exploiting and Resolving Investor Sentiment

Prior research shows that investor sentiment influences stock prices and that insiders are able to predict future stock returns. In this paper, I examine whether insiders trade against market wide investor sentiment. Next, I investigate whether insider transactions send signals to outsiders that help to resolve investor sentiment. Consistent with my expectations, I find that insiders trade against investor sentiment and this trading pattern is stronger among firms that are most affected by investor sentiment. Furthermore, I predict and find that the market reaction to insider purchase disclosure is more positive when sentiment is low and the reaction to insider sale disclosure is more negative when sentiment is high. Collectively, the results in this study show that insiders exploit investor sentiment for their personal trading decisions and that the market reaction to these trades pushes stock prices towards fundamentals.