Equilibrium Analysis of an Insider Trading Model With Constraints in Transparent Markets

ABSTRACT Based on the work of Choi et al. (2023) and Han et al. (2023), this paper develops an insider trading model with trading constraints in a transparent market, where regulatory securities laws mandate public disclosure of insider trading volume. Utilizing dynamic programming principles and filtering theory, we derive a closed‐form market equilibrium characterized by a mixed trading strategy and distinct market prices in the trading and updating phases. Our analysis demonstrates that, in contrast to an opaque market, at the equilibrium of this transparent market, disclosure rules and the mixed strategy adopted by the insider adding a noise term (with volatility consistent with that of noise traders) together reduce market liquidity, slow down the speed of information disclosure, and result in a higher remaining variance that decreases gradually. Meanwhile, this mechanism significantly compresses insiders' profits and effectively protects the interests of noise traders.