Trading on Private Information: Evidence from Members of Congress

AuthorSerkan Karadas
Published date01 February 2019
Date01 February 2019
The Financial Review 54 (2019) 85–131
Trading on Private Information: Evidence
from Members of Congress
Serkan Karadas
Sewanee: The University of the South
I examine the stock trades of members of Congress and find that over2004–2010 the buy-
minus-sell portfolios of powerful Republicans have the highest abnormal returns, exceeding
35% on an annual basis under a one-week holding period. Among powerful Republicans, the
abnormal returns are mostly concentrated in the portfolios of those with less trading experience.
I also find that the positive abnormal returns disappear after the Stop Tradingon Congressional
Knowledge (STOCK) Act was passed in 2012. My results imply that the STOCK Act affected
politicians’ incentives to trade on privateinformation, which they acquired through their power
and party membership.
Keywords: private information, informed trading, congressional trading, STOCK Act,
JEL Classifications: G12, G14, G18
Corresponding author: Department of Economics, Sewanee: The Universityof the South, 735 University
Ave,Sewanee, TN 37383; Phone: (931) 598-1211; Fax: (931) 598-3229; E-mail:
I am grateful for helpful comments and suggestions from Richard S. Warr(the Editor) and the anonymous
referees. I also thank Ron Balvers, Stratford Douglas, Alex Kurov, Harry Turtle, Josh Hall, Minh Tam
T. Schlosky,Jorida Papakroni, Chris Bollinger, the seminar participants at West Virginia University, and
the participants at the 2014 Southwestern Finance Association, 2014 Eastern Finance Association, 2013
Southern Economic Association, and 2013 Pennsylvania Economic Association meetings for their helpful
comments and suggestions. All remaining errors are mine. This paper was previously titled as “Informed
Trading at Capitol Hill: Evidence from Congressional Trading” and was presented under that title.
C2019 The Eastern Finance Association 85
86 S. Karadas/The Financial Review 54 (2019) 85–131
1. Introduction
The STOCK Act makes it clear that if members of Congress use nonpublic information
to gain an unfair advantage in the market, then they are breaking the law. It creates
new disclosure requirements and new measures of accountability and transparency for
thousands of federal employees. That is a good and necessary thing. We were sent here
to serve the American people and look out for their interests—not to look out for our
own interests.
Former President Barack Obama, April 4, 20121
Alleged insider trading by members of Congress caused mounting public pres-
sure, which served as a catalyst for the passage of the Stop Trading on Congressional
Knowledge (STOCK) Act of 2012.2The STOCK Act was enacted “to prohibit Mem-
bers of Congress and employees of Congress from using nonpublic information
derived from their official positions for personal benefit, and for other purposes.”3
Legislating the way that members of Congress trade stocks has received a great
deal of media attention, but there are very few academic studies on this issue (see,
e.g., Ziobrowski, Cheng, Boyd and Ziobrowski, 2004; Ziobrowski, Boyd, Cheng and
Ziobrowski, 2011). Also, there are still unanswered questions such as Do politicians
actually trade on private information, or do they possess superior skills?;What deter-
mines access to private information?; and so forth. Furthermore, there is an ongoing
debate on whether the STOCK Act was really necessary and whether it had any
purpose beyond improving Congress’s image.
Members of Congress (politicians) differ from ordinary traders in that they
generate or have access to private information that has the potential to move stock
prices substantially. For example, the Washington Post reports that there was an
unusual trading activity in the options of Humana, a health insurer, after a staffer
on the Senate Finance Committee talked about the prospects of a critical Medicare
bill in a conference call organized by Capitol Street, a consulting firm, on March
18, 2013. On April 2, 2013, the government officially announced a rate increase
for Medicare-participating insurers, which generated 500% or more returns on the
options bought right after the conference call.4
In this paper, I ask whether politicians trade on private information. If they do, I
strive to understand the nature of their privateinformation and to find out what factors
contribute to their access to private information. The possibility existsthat politicians
2For example, see Economist (2011) and Kroft (2011) for the public’s viewof congressional trading.
4See ElBoghdady and Hamburger (2013a,b) and Yang,Hamburger and ElBoghdady (2013) for some of
the press coverage by the Washington Post on this incidence of alleged insider trading. The Wall Street
Journal also covered this story (see Mullins and McGinty,2013a,b,c,d; Mullins, Strasburg and McGinty,
S. Karadas/The Financial Review 54 (2019) 85–131 87
may choose not to trade on private information even if they possess it. However,
public choice theory suggests that politicians, like any other individual, also work
toward pursuing their self-interests. For example, Buchanan (1989, p. 20) states that
“individuals must be modeled as seeking to further their own self-interest, narrowly
defined in terms of their measured net wealth positions, as predicted or expected.”
I build my empirical framework on transactions-based calendar time portfolios
using 61,998 stock trades that politicians made over the 2004–2010 period. I first
separately calculate the returns on a portfolio that contains the stocks bought by
politicians and the returns on a portfolio that contains the stocks sold by politicians
(i.e., previously long positions). I refer to these portfolios as the buy portfolio and the
sell portfolio, respectively. I assume five holding periods, ranging from one week to
one year, in my return calculations. For example, under a one-week holding period,
a buy transaction stays in the buy portfolio for one week and then it gets discarded.
Likewise, a sell transaction stays in the sell portfolio for one week and then it gets
discarded. My empirical analysis focuses on the return differences between the buy
portfolio and the sell portfolio (i.e., the returns on the buy-minus-sell portfolio).5
I document that the portfolios of powerful politicians (those with powerful com-
mittee assignments) outperform the market by more than 20% on an annual basis
under a one-week holding period. However, therei svery weak evidence of informed
trading for nonpowerful members of Congress. Among powerful politicians, the port-
folios of Republicans outperform the market by more than 35% on an annual basis
under a one-week holding period. This superior performance persists even after Re-
publicans lost majority control of Congress in the 2006 elections. On the other hand,
the portfolios of Democrats mostly earn average returns, even when they controlled
Congress. My further analysis of powerful Republicans’ transactions reveals that the
portfolios of inexperienced (i.e., unsophisticated) investors earn abnormal returns
under a one-week, one-month, two-month, and three-month holding period, whereas
the abnormal returns on the portfolios of experienced (i.e., sophisticated) investors do
not extend beyond a one-week holding period. This result implies that the abnormal
returns are driven mostly by private information, not by trading experience or skill.
I present evidence that both the advisor-assisted and the self-managed port-
folios of unsophisticated powerful Republicans earn abnormal returns, suggesting
that politicians obtain some of their private information from their financial ad-
visors. I explore whether powerful Republicans also acquire private information
through their interactions with firms that provide them with campaign contribu-
tions and through their involvement in the purchasing decisions of the federal gov-
ernment. I find evidence that these channels produce economically significant, but
5It is important to note that the sell side of the buy-minus-sell portfolio contains the stocks that politicians
sold, not those that politicians shorted. For example, let us suppose that politician A owns shares of ABC
Inc. in her portfolio. When she sells shares of ABC Inc., this transaction becomes part of the sell portfolio.

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