Aurora Borealis
1 August 2014 CFA Institute Journal Review

Informed Trading through the Accounts of Children (Digest Summary)

  1. Derek W. Johnson, CFA

Guardians trading in accounts of underage children are successful at picking stocks compared with investors in older age groups. They are especially successful at picking stocks before major earnings announcements, large price changes, and takeover announcements.

What’s Inside?

The investment accounts of children aged 0–10 years old tend to perform better than the accounts of older age groups. The authors find that the reason for this outperformance is attributable to the successful trading of stocks by the guardian of the child. They analyze the reasons behind this success and find that the success of the guardians is related to better information around big movements in stock prices that occurred before major information events, earnings announcements, and takeover announcements. The authors measure the level of information by looking at the proportion of total trading activity through underage accounts, which they label “BABYPIN.” They believe that variable can serve as an effective proxy for the probability of information trading in a stock. The authors also find that guardians who trade on behalf of the underage accounts process greater information about these events than do older accountholders. The evidence suggests this finding is especially true for takeover announcements.

How Is This Research Useful to Practitioners?

The identification of stocks that are bought and sold in underage accounts could help investors spot companies that are being traded with inside information. The authors’ research suggests that underage accounts outperform accounts from other age groups because of trading before major news events, surprise earnings announcements, and takeover announcements. By identifying these unusual trades, investors would be able to uncover inefficiencies within the equity market; these inefficiencies tend to last anywhere from 1 to 10 days before the event.
Guardians who open accounts for children under the age of 10 years tend to be wealthier and more successful investors than other adults. By following the trading patterns of these guardians through the underage accounts, investors could possibly identify what other successful investors are doing. Although the authors do not examine the legal aspects of insider trading, regulators might be able to find illegal trading activity by examining the trades done in underage accounts before a major release of privately held information.

How Did the Authors Conduct This Research?

The authors use data from Euroclear Finland Ltd. for 1995–2010. Euroclear records all changes in daily shareholdings for every investor trading on the NASDAQ OMX Helsinki exchange, as well as the age of the investor. The authors group the accounts by six different age groups: 0–10, 11–20, 21–40, 41–60, 61–80, and above 80 years of age. They identify two subsets of guardians for the two categories of underage accounts that are matched either by family name or by trades through corporate accounts. The authors obtain earnings announcement dates from Bloomberg and merger and acquisition announcement dates from SDC Platinum. Daily share prices and the number of shares outstanding are from Compustat Global.
Using a Fama–MacBeth regression approach, the authors analyze the investment skills of different age groups. They measure accounts that traded in a stock before large price changes, large price changes attributable to a surprise earnings event, and large price changes attributable to takeover announcements. The authors measure both buys and sells for which the one-day price move was greater than 4%. To test the hypothesis that the guardians were trading with an information advantage versus simply being above-average investors, the authors examine the performance of two subsets of underage accountholders: those who were successful because of multiple events that happened to one stock or in one type of industry and those who were successful in multiple stocks across many industries.
If the guardians are trading based on inside information, then much of the above-average performance should be the result of trading in individual firms or industries rather than success across multiple firms or industries. The authors find that both sets of trades are successful. But the individual firm and industry trades have much higher success rates and returns, which confirms the authors’ suspicion that guardians are trading with privately held information. The authors also research the characteristics of the stocks traded by guardians because the outperformance could have resulted from the guardians favoring certain types of stocks. But they find that the stocks traded by the guardians are not substantially different.

Abstractor’s Viewpoint

This research uncovers very interesting and possibly lucrative information about identifying investors who make informed trades based on privately held information. I would like to see this research conducted over a larger sample and broader market outside of the Helsinki stock market to determine whether it has relevance elsewhere.

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