An Intelligent System for Insider Trading Identification in Chinese Security Market

Abstract

Insider trading is one kind of criminal behaviors in security markets. It has existed since the birth of the security market. Until 2018, the history of the Chinese security market is less than 30 years, nonetheless, insider trading behavior frequently occurred. In this study, we mainly explore the features of insider trading behavior by studying relevant indicators during the sensitive period (time window length before the release of insider information). For this purpose, an intelligent system with an integration method of Principal Component Analysis (PCA) and Random Forest (RF) is proposed to identify insider tradings in Chinese security market. In the proposed method, we first collect twenty-six relevant indicators for insider trading samples that occurred from 2007 to 2017 and corresponding non-insider trading samples in Chinese security market. Next, by using the PCA, indicator dimension is reduced and principal components are extracted. Then, relations between insider trading samples and principal components are learnt by the RF algorithm. In the identification phase, the trained PCA-RF model is applied to classify the insider trading and non-insider trading samples, as well as analyzing the relative importance of indicators for insider trading identification. Experimental results showed us that under the 30-, 60-, and 90-days time window lengths, recall results of the proposed method for the out-of-samples identification were 73.53%, 83.87%, and 79.41%, respectively. We further investigate the voting threshold of RF for the proposed method, and we found when the voting threshold of RF was increased to more than 70%, the proposed method produced identification accuracy up to more than 90%. In addition, the relative importance result of RF indicated that three indicators were crucial for insider trading identification. Moreover, identification accuracy and efficiency of the proposed method were substantially superior to benchmark methods. In summary, experimental results indicated that the proposed method could be efficiently applied to Chinese security market. Thus, the proposed method can provide useful suggestions to market regulators for insider trading investigations.

Appendix

• (1) Volatility

  It is the degree of variation of a security price time series over time that measured by the standard deviation of logarithmic returns.

• (2) ERCSS (Excess Return Compared with Same Scale):

  It is the excess rate of return on a security over the average return of the securities with the same scale. The calculation formula is as follows:

  $$ {\text{ERCSS}} = {\text{Return}}\;{\text{of}}\;{\text{security}} - {\text{Return}}\;{\text{of}}\;{\text{securities}}\;{\text{with}}\;{\text{same}}\;{\text{company}}\;{\text{scale}} $$

• (3) ERCSM (Excess Return Compared with Same Market):

  It is the excess rate of return over the average return of the market. The calculation formula is as follows:

  $$ {\text{ERCSM}} = {\text{Return}}\;{\text{of}}\;{\text{security}} - {\text{Return}}\;{\text{of}}\;{\text{market}} $$

• (4) ERCSR (Excess Return Compared with Same Risk)

  It is the excess rate of return over the average return of the investment with same risk. The calculation formula is as follows:

  $$ {\text{ERCSM}} = {\text{Return}}\;{\text{of}}\;{\text{security}} - {\text{Return}}\;{\text{of}}\;{\text{the}}\;{\text{investment}}\;{\text{with}}\;{\text{same}}\;{\text{risk}} $$

• (5) SC (Sigma Coefficient)

  The SC is the standard deviation of security prices in a certain period.

• (6) TSTR (Total Share Turnover Rate)

  It is the frequency of stock transfer in a certain period. The formula is as follows:

  $$ {\text{TSTR}} = ({\text{Volume}}\;{\text{of}}\;{\text{transaction}}/{\text{Total}}\;{\text{stocks}}) \times \, 100\% $$

• (7) FSTR (Floating Stock Turnover Rate)

  It is used to measure the degree of the frequency of stock transfer in a certain period. The formula is as follows:

  $$ {\text{FSTR}} = ({\text{Volume}}\;{\text{of}}\;{\text{transaction}}/{\text{Floating}}\;{\text{stocks}}\;{\text{in}}\;{\text{circulation}}) \times \, 100\% $$

• (8) BC (Beta Coefficient)

  The BC is a measure of an asset’s risk and return in relation to a market. A security’s beta coefficient is calculated by dividing the product of the covariance of the security’s returns and the benchmark’s returns by the product of the variance of the benchmark’s returns over a certain period.

• (9) P/E ratio (Price-Earning ratio)

  P/E ratio is the ratio of a company’s stock price to the company’s earnings per share, which is used in valuing companies, which is calculated by:

  $$ {\text{P/E}} = {\text{Share}}\;{\text{Price}}/{\text{Earnings}}\;{\text{Per}}\;{\text{Share}} $$

• (10) P/B ratio (Price-Book ratio)

  The price-to-book ratio, or P/B ratio, is a financial ratio used to compare a company’s current market price to its book value. It is calculated as:

  $$ {\text{P/B}} = {\text{Market Price Per Share}}/{\text{Book Value Per Share}}$$

• (11) P/S ratio (Price-Sales ratio)

  Price–sales ratio, or P/S ratio, is a valuation metric for stocks. It is calculated by dividing the company’s stock price by the revenue per share:

  $$ {\text{P/S}} = {\text{Share}}\;{\text{Price}}/{\text{Revenues}}\;{\text{Per}}\;{\text{Share}} $$

• (12) DR (Debt Ratio)

  The DR is a financial ratio that indicates the percentage of a company’s assets that are provided via debt. It is the ratio of total liabilities and total assets. The calculation formula is as follows:

  $$ {\text{DR}} = \left( {{\text{Total}}\;{\text{Liabilities}}/{\text{Total}}\;{\text{Assets}}} \right) \times \, 100\% $$

• (13) CR (Current Ratio)

  It is a ratio that measures whether a company has enough resources to meet its short-term obligations. It compares a company’s current assets to its current liabilities:

  $$ {\text{CR}} = ({\text{Current}}\;{\text{Assets}}/{\text{Current}}\;{\text{Liabilities}}) \times \, 100\% $$

• (14) OPR (Operating Profit Ratio)

  It refers to the percentage of operating profit from operating income as a percentage of net sales. This percentage is used to comprehensively reflect the business efficiency of a company. The calculation formula is as follows:

  $$ {\text{OPR}} = ({\text{Operating}}\;{\text{profit}}/{\text{Net Sales}}\times \, 100\% $$

• (15) QR (Quick Ratio)

  The QR refers to the ratio of the company’s quick assets and current liabilities. It is calculated as follows:

  $$ {\text{QR}} = ({\text{Quick}}\;{\text{assets}}/{\text{Current}}\;{\text{liabilities}}) \times 100\% $$

• (16) TAT (Total Asset Turnover)

  The TAT is the ratio of the net sales income to the average total assets in a certain period of time. The calculation formula is as follows:

  $$ {\text{TAT}} = {\text{Sales}}\;{\text{Revenue}}/{\text{Total}}\;{\text{Assets}} $$

• (17) RGR (Revenue Growth Rate)

  The RGR refers to the ratio of the increase in operating income of the company to the total operating income of the previous year. The calculation formula is as follows:

  $$ {\text{RGR}} = \left( {{\text{Increased}}\;{\text{operating}}\;{\text{income}}/{\text{Total}}\;{\text{operating}}\;{\text{income}}\;{\text{in}}\;{\text{the}}\;{\text{previous}}\;{\text{year}}} \right) \times 100\% $$

• (18) TAGR (Total Asset Growth Rate)

  The TAGR is the ratio of the total assets growth of the listed company to the total assets at the beginning of the current year, reflecting the growth of the assets of the company in the current year. The calculation formula is as follows:

  $$ {\text{TAGR}} = ({\text{Total asset growth in the current year}}/{\text{Total assets at the beginning of the current year}}) \times 100\% $$

• (19) ROE (Return On Equity)

  The ROE is a ratio of net income and to the Shareholders Equity.

  $$ {\text{ROE}} = {\text{Net}}\;{\text{Income}}/{\text{Shareholders Equity}}$$

• (20) ROA (Return On Assets)

  The ROA is an indicator used to measure how much net profit is generated per unit of assets. The calculation formula is as follows:

  $$ {\text{ROA}} = {\text{Net}}\;{\text{Income}}/{\text{Total Value of Assets}} $$

• (21) CR5 Index

  It is the proportion of shares held by the top five largest shareholders

• (22) CR10 Index

  It is the Proportion of shares held by the top ten largest shareholders

• (23) Z index

  The Z index refers to the ratio of the largest shareholder’s stock amount to the second-largest shareholder’s stock amount.

• (24) H5 index

  It is the sum of squares of the top five largest shareholders’ stock proportion. The closer of the index to 1, the greater the stock proportion difference between the top five largest shareholders.

• (25) H10 index

  It is the sum of squares of the top ten largest shareholders’ stock proportion. The closer the index to 1, the greater the stock proportion difference between the top ten largest shareholders.

• (26) ARAGMS (Attendance Ratio at Annual General Meeting of Shareholders)

  The ARAGMS is a ratio of the shareholder number with the total number of shareholders that attending at the annual general meeting.