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Are Hedge Funds More Skilled than Other Institutional Investors? Evidence from Their Use of Insider Trading Information

This study examines the use of insider trading information by hedge funds. We find that hedge funds tend to trade in the same direction as insiders when insider trading is likely driven by information, but do not respond to likely liquidity-driven insider trades. This finding is consistent with hedge funds being able to decipher insider trading information and trade accordingly. In contrast, mutual funds, pension funds and other institutional investors (mostly banks and insurance companies) are more likely to trade in the opposite direction as insiders, acting as liquidity providers regardless of the trading motives of insiders. Further, there is evidence that a hedge fund’s ability to exploit insider trading information helps improve its performance. Our study contributes to the literature on hedge fund skills by showing their ability to exploit insider information and linking such ability to performance. ‡ All three authors are at School of Banking and Finance, USW Business School, UNSW Australia. The emails are j.parwada@unsw.edu.au, y.rui@unsw.edu.au, and Jianfeng.shen@unsw.edu.au respectively.