Abstract

http://ssrn.com/abstract=2243305
 
 

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Short-Sale Constraints, Bid-Ask Spreads, and Information Acquisition


Hong Liu


Washington University in St. Louis - Olin Business School; China Academy of Financial Research (CAFR)

Yajun Wang


Robert H. Smith School of Business, University of Maryland

April 2, 2013


Abstract:     
Short-sale constraints are prevalent in many financial markets and have been actively adjusted by regulators to tackle problems in markets. However, how short-sale constraints affect market liquidity and information acquisition is still an open question. In this paper, we develop an equilibrium model to study this question in the presence of information asymmetry, inventory risk, and imperfect competition among market makers. In contrast to Diamond and Verrecchia (1987) and consistent with empirical findings, we show that the equilibrium bid (ask) price with short-sale constraints is lower (higher) than the bid (ask) price without short-sale constraints, which implies that short-sale constraints not only increase bid-ask spreads but also decrease both bid and ask depths. In addition, short-sale constraints increase liquidity risk measured by the volatility of bid-ask spreads. The presence of asymmetry information can further magnify the adverse impact of short-sale constraints on market liquidity. Furthermore, short-sale constraints make all non-market maker investors worse off while they may benefit market makers in equilibrium when there is significant competition. Interestingly, the presence of short-sale constraints may increase investors’ incentive to produce more precise information and thus improve aggregate information quality.

Number of Pages in PDF File: 38

Keywords: Short-sale Constraints, Bid-Ask Spread, Information Acquisition, Imperfect Competition, Welfare

JEL Classification: D42, D53, D82, G12, G18

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Date posted: April 4, 2013  

Suggested Citation

Liu, Hong and Wang, Yajun, Short-Sale Constraints, Bid-Ask Spreads, and Information Acquisition (April 2, 2013). Available at SSRN: http://ssrn.com/abstract=2243305 or http://dx.doi.org/10.2139/ssrn.2243305

Contact Information

Hong Liu
Washington University in St. Louis - Olin Business School ( email )
One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-5883 (Phone)
China Academy of Financial Research (CAFR)
1954 Huashan Road
Shanghai P.R.China, 200030
China

Yajun Wang (Contact Author)
Robert H. Smith School of Business, University of Maryland ( email )
Robert H. Smith School of Business
University of Maryland
College Park, MD 20742
United States
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