The Nonlinear Library LW - Congressional Insider Trading by Maxwell Tabarrok
Aug 31, 2024
11:34
Welcome to The Nonlinear Library, where we use Text-to-Speech software to convert the best writing from the Rationalist and EA communities into audio. This is: Congressional Insider Trading, published by Maxwell Tabarrok on August 31, 2024 on LessWrong.
You've probably seen the
Nancy Pelosi Stock Tracker on X or else a
collection of
articles and
books exposing the secret and lucrative world of congressional insider trading.
The underlying claim behind these stories is intuitive and compelling. Regulations, taxes, and subsidies can
make or break entire industries and congresspeople can get information on these rules before anyone else, so it wouldn't be surprising if they used this information to make profitable stock trades.
But do congresspeople really have a consistent advantage over the market? Or is this narrative built on a cherrypicked selection of a few good years for a few lucky traders?
Is Congressional Insider Trading Real
There are several papers in economics and finance on this topic
First is the 2004 paper:
Abnormal Returns from the Common Stock Investments of the U.S. Senate by Ziobrowski et al. They look at Senator's stock transactions over 1993-1998 and construct a synthetic portfolio based on those transactions to measure their performance.
This is the headline graph. The red line tracks the portfolio of stocks that Senators bought, and the blue line the portfolio that Senators sold. Each day, the performance of these portfolios is compared to the market index and the cumulative difference between them is plotted on the graph. The synthetic portfolios start at day -255, a year (of trading days) before any transactions happen.
In the year leading up to day 0, the stocks that Senators will buy (red line) basically just tracks the market index. On some days, the daily return from the Senator's buy portfolio outperforms the index and the line moves up, on others it underperforms and the line moves down. Cumulatively over the whole year, you don't gain much over the index.
The stocks that Senators will sell (blue line), on the other hand, rapidly and consistently outperform the market index in the year leading up to the Senator's transaction.
After the Senator buys the red portfolio and sells the blue portfolio, the trends reverse. The Senator's transactions seem incredibly prescient. Right after they buy the red stocks, that portfolio goes on a tear, running up the index by 25% over the next year. They also pick the right time to sell the blue portfolio, as it barely gains over the index over the year after they sell.
Ziobrowski finds that the buy portfolio of the average senator, weighted by their trading volume, earns a compounded annual rate of return of 31.1% compared to the market index which earns only 21.3% a year over this period 1993-1998.
This definitely seems like evidence of incredibly well timed trades and above-market performance. There are a couple of caveats and details to keep in mind though.
First, it's only a 5-year period. Additionally, any transactions from a senator in a given year a pretty rare:
Only a minority of Senators buy individual common stocks, never more than 38% in any one year.
So sample sizes are pretty low in the noisy and highly skewed distribution of stock market returns.
Another problem, the data on transactions isn't that precise.
Senators report the dollar volume of transactions only within broad ranges ($1,001 to $15,000, $15,001 to $50,000, $50,001 to $100,000, $100,001 to $250,000, $250,001 to $500,000, $500,001 to $1,000,000 and over $1,000,000)
These ranges are wide and the largest trades are top-coded.
Finally, there are some pieces of the story that don't neatly fit in to an insider trading narrative. For example:
The common stock investments of Senators with the least seniority (serving less than seven years) outperform the investments of the most senior Senators (serving more than 16 years) by a statistically significant margin.
Still though,
several
other
paper...
You've probably seen the
Nancy Pelosi Stock Tracker on X or else a
collection of
articles and
books exposing the secret and lucrative world of congressional insider trading.
The underlying claim behind these stories is intuitive and compelling. Regulations, taxes, and subsidies can
make or break entire industries and congresspeople can get information on these rules before anyone else, so it wouldn't be surprising if they used this information to make profitable stock trades.
But do congresspeople really have a consistent advantage over the market? Or is this narrative built on a cherrypicked selection of a few good years for a few lucky traders?
Is Congressional Insider Trading Real
There are several papers in economics and finance on this topic
First is the 2004 paper:
Abnormal Returns from the Common Stock Investments of the U.S. Senate by Ziobrowski et al. They look at Senator's stock transactions over 1993-1998 and construct a synthetic portfolio based on those transactions to measure their performance.
This is the headline graph. The red line tracks the portfolio of stocks that Senators bought, and the blue line the portfolio that Senators sold. Each day, the performance of these portfolios is compared to the market index and the cumulative difference between them is plotted on the graph. The synthetic portfolios start at day -255, a year (of trading days) before any transactions happen.
In the year leading up to day 0, the stocks that Senators will buy (red line) basically just tracks the market index. On some days, the daily return from the Senator's buy portfolio outperforms the index and the line moves up, on others it underperforms and the line moves down. Cumulatively over the whole year, you don't gain much over the index.
The stocks that Senators will sell (blue line), on the other hand, rapidly and consistently outperform the market index in the year leading up to the Senator's transaction.
After the Senator buys the red portfolio and sells the blue portfolio, the trends reverse. The Senator's transactions seem incredibly prescient. Right after they buy the red stocks, that portfolio goes on a tear, running up the index by 25% over the next year. They also pick the right time to sell the blue portfolio, as it barely gains over the index over the year after they sell.
Ziobrowski finds that the buy portfolio of the average senator, weighted by their trading volume, earns a compounded annual rate of return of 31.1% compared to the market index which earns only 21.3% a year over this period 1993-1998.
This definitely seems like evidence of incredibly well timed trades and above-market performance. There are a couple of caveats and details to keep in mind though.
First, it's only a 5-year period. Additionally, any transactions from a senator in a given year a pretty rare:
Only a minority of Senators buy individual common stocks, never more than 38% in any one year.
So sample sizes are pretty low in the noisy and highly skewed distribution of stock market returns.
Another problem, the data on transactions isn't that precise.
Senators report the dollar volume of transactions only within broad ranges ($1,001 to $15,000, $15,001 to $50,000, $50,001 to $100,000, $100,001 to $250,000, $250,001 to $500,000, $500,001 to $1,000,000 and over $1,000,000)
These ranges are wide and the largest trades are top-coded.
Finally, there are some pieces of the story that don't neatly fit in to an insider trading narrative. For example:
The common stock investments of Senators with the least seniority (serving less than seven years) outperform the investments of the most senior Senators (serving more than 16 years) by a statistically significant margin.
Still though,
several
other
paper...