Insider networks

Erol, Selman; Lee, Michael Junho

Report

Insider networks

Abstract: How do insiders respond to regulatory oversight? History suggests that they form sophisticated networks to share information and circumvent regulation. We develop a theory of the formation and regulation of information transmission networks. We show that agents with sufficiently complex networks bypass any given regulatory environment. In response, regulators employ broad regulatory boundaries to combat gaming, giving rise to regulatory ambiguity. Tighter regulation induces agents to migrate transmission activity from existing social networks to a core-periphery insider network. A small group of agents endogenously arise as intermediaries for the bulk of information. We provide centrality measures that identify intermediaries.

Keywords: network formation; endogenous intermediation; regulatory ambiguity; insider trading;

JEL Classification: G14; D85; G20;