Information Leakage and Market Efficiency

This paper analyzes the effects of information leakage on trading behavior and market efficiency. It shows that a trader who receives a leaked signal prior to a public announcement can exploit this private information twice. First, when he receives his signal, and second, at the time of the public announcement. The latter effect occurs because he can best infer the extent to which his information is already reßected in the pre-announcement price. The analysis also shows that the early-informed trader trades aggressively prior to the public announcement and intends to unwind part of the acquired position after it. While information leakage makes the price process more informative in the very short-run, it reduces its informativeness in the long-run. Hence, the analysis provides strong support for SEC’s Regulation FD. JEL ClassiÞcation: D82, D83, D84, G12, G13, G14