Style Timing with Insiders

Abstract

Aggregate demand by insiders predicts time-series variation in the value premium. Insider trading forecasts the value premium because insiders sell (buy) when markets—especially growth stocks—are overvalued (undervalued). This article suggests that investors can use signals from aggregate insider behavior to adjust style tilts and exploit sentiment-induced mispricing. lthough value stocks average higher returns than growth stocks (see, e.g., Chan and Lakonishok 2004), a value tilt does not ensure a positive alpha over any given period because growth often outperforms value. In this study, we investigated whether investors can use aggregate demand by corporate insiders to forecast time-series variation in the value premium—that is, whether a high level of insider buying signals that the future value premium will be lower (growth beats value) and whether insider selling portends a higher value premium (value beats growth). We hypothesized three reasons that insider demand may forecast the value premium. First, time-series variation in the value premium may arise, at least in part, because of changes in macroeconomic fundamental risk and insider demand varies with risk. Second, growth stocks may have larger “cash flow betas ” than value stocks and insiders may trade on the basis of private infor-mation about future cash flows. Third, insiders may trade against systematic market sentiment and growth stocks may suffer from larger sentiment-induced pricing errors than value stocks.