The Cost of Insider Trading: Evidence from Defined Markets

Abstract

In this paper, two complementary markets for bets on UK horse races are examined for evidence of information inefficiency in the form of unexploited price differentials between these markets for the same product. It is shown that bettors could on average improve their expected return by shifting their betting patterns in a defined way. Evidence is adduced which supports the hypothesis that the apparent inefficiency is a consequence of perceived insider activity. In particular, in situations where there are likely to be limited opportunities for insider trading, the `inefficiency' disappears. Although the evidence produced here applies to a relatively unsophisticated market, it poses legitimate questions about the operation of more complex financial markets.