The Senate Premium: Legislative Information Asymmetry and Stock

ABSTRACT Information asymmetry induced by legislative activity has been largely overlooked in the literature, despite the opacity of the legislative process and the legality of information sharing by politicians with third parties. Using aggregate equity trading by U.S. senators, we develop a two‐stage model of legislative information asymmetry that involves a direct effect followed by propagated trading of third parties. We find that firms in industries with high levels of senatorial trading face increased volatility, wider bid‐ask spreads, and greater idiosyncratic risk. Because size is associated with a firm's ability to lobby, we discover that the risk of larger firms is less affected by this information asymmetry. While banning politicians' trading might address the ethical problems inherent in political insider trading, our results demonstrate that it will not address the legislative information asymmetry. Instead, the goal should be to address the issue of selective information sharing and its legality.