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Insider Trading Laws as a Defeat Device

Insider trading laws are designed to ensure a level-playing field and trust in financial markets at the expense of less efficient markets. This paper argues that insider trading laws fail to ensure a level-playing field and instead facilitate fraud and undermine trust and fairness. We use a model to show that insider trading laws result in delayed price movements, lower liquidity, increased volatility and crash risk. A welfare analysis further shows that informed traders benefit the most from insider trading laws. An empirical example, the Volkswagen Diesel scandal, supports the predictions of the theoretical model and relates the emissions testing defeat device to insider trading laws that act as an informational defeat device.