No One Has Any Idea What Goes On in a Bank

Insiders aren't any better than outsiders when it comes to trading their own stock.

No clue.

Photograph: Bloomberg
This post originally appeared in Money Stuff.

Here is a pleasing Bank for International Settlements working paper by Fabrizio Spargoli and Christian Upper looking into bank opacity. "Conventional wisdom maintains there are severe information asymmetries between a bank's management and outside investors," they begin, and then they check to see if that is true by looking into whether bank executives are any better at trading their own stock than anyone else. The answer is meh, not really:

On average, bank insider sales do not earn an abnormal return and do not predict stock returns. By contrast, bank insider purchases do, even though less than other firms. Our within-banking sector and over-time analyses also fail to provide evidence of greater opacity of banks vis-à-vis other firms. 

One possible explanation of this result is that banks provide investors with all of the information they need to fully understand their businesses. (Banks are not opaque.) Another possible explanation is that banks' disclosure is bad, but no worse than anyone else's. (Banks are opaque but so is everyone.) A third possible explanation is that disclosed trading by officers and directors, especially at highly regulated banks, is never done with an information advantage, because the only time you feel safe trading is when you don't know any more than the market does, and you use a 10b5-1 plan to avoid making informed trades. (Banks are opaque but not in a way that can be measured by insider trading.)

A fourth explanation, one which I kind of like, is that banks are impossible for outside investors to understand, but they are equally impossible for well-informed executives and directors to understand. The insiders have more data, and perhaps even more understanding of how the business works, but no more understanding of what will happen tomorrow than anyone else has. In this view, banks are radically opaque: Not only can you not see into them from the outside, but even when you get inside and look around, you still can't see anything. Jayanth Varma writes:

Banks are so opaque that even insiders cannot see through the opacity when bad things happen. Sometimes, as in the case of the London Whale, a market participant outside the bank has greater visibility to what is going on.

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