Rational Information Leakage

Empirical evidence suggests that information leakage in capital markets is common. We present a trading model to study the incentives of an informed trader (e.g., a well informed insider) to voluntarily leak information about an asset’s value to another independent trader. Our model shows that, while leaking information dissipates the insider’s information advantage about the asset’s value, it enhances his information advantage about the asset’s execution price relative to other informed traders. These two effects are countervailing. When the profit impact from enhanced information about the execution price dominates, the insider has incentives to leak some of his private information. We label this rational information leakage and discuss its implications for empirical research and the regulation of insider trading.