Behavioral effects of capital market regulations on investor (ir)rationality and market (in)efficiency: Evidence from MAD and TPD EU directives

Regulatory reform has the potential to shape behavior and hence the functioning of economic institutions. We examine whether the EU Market Abuse Directive (MAD) and Transparency Directive (TPD) reduced irrational herding/anti-herding of investors, hence improving informational efficiency of capital markets. Using daily stock-level data from ten EU markets, we find pre-MAD anti-herding, which was eliminated post-MAD, while TPD enactment provided no additional benefits in curbing irrational investor behavior and market inefficiency. We further investigate market- and non-market-related explanations of our findings, and find that pre-reform market behavior is indicative of overconfidence and weak self-control of investors (proxied by national culture). Our results indicate that a regulatory reform (MAD) aimed at addressing the misuse of private information led to a substitution of irrational for information-driven trading, hence promoting market efficiency.