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Modern-day financial systems are highly complex, with billions of exchanges in information, assets, and funds between individuals and institutions. Though daunting to operationalize, regulating these transmissions may be desirable in some instances. For example, securities regulators aim to protect investors by tracking and punishing insider trading. Recent evidence shows that insiders have formed sophisticated networksthat enable them to pursue activities outside the purview of regulatory oversight. In understanding the cat-and-mouse game between regulators and insiders, a key consideration ...
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 ...