Short-Sale Constraints and the Idiosyncratic Volatility Puzzle: An Event Study Approach

56 Pages Posted: 24 Sep 2007 Last revised: 16 Jul 2014

See all articles by Danling Jiang

Danling Jiang

College of Business, Stony Brook University

David R. Peterson

Florida State University - Department of Finance

James Doran

University of New South Wales

Date Written: February 25, 2014

Abstract

Using three natural experiments, we test the hypothesis that investor overconfidence produces overpricing of high idiosyncratic volatility stocks in the presence of binding short-sale constraints. We study three events: IPO lockup expirations, option introductions, and the 2008 short-sale ban on financial firms. Consistent with our prediction, we show that when short-sale constraints are relaxed, event stocks with high idiosyncratic volatility tend to experience greater price reductions, as well as larger increases in trading volume and short interest, than those with low idiosyncratic volatility. These results hold when we benchmark event stocks with non-event stocks with comparable idiosyncratic volatility. Overall, our findings suggest that biased investor beliefs and binding short-sale constraints contribute to idiosyncratic volatility overpricing.

Keywords: Idiosyncratic Volatility, Short-Sale Constraints, IPO Lockup, Option Introduction, Short-Sale Ban

JEL Classification: G12, G14, G18

Suggested Citation

Jiang, Danling and Peterson, David R. and Doran, James, Short-Sale Constraints and the Idiosyncratic Volatility Puzzle: An Event Study Approach (February 25, 2014). Journal of Empirical Finance, 2014 (28): 36-59. Available at SSRN: https://ssrn.com/abstract=1016112 or http://dx.doi.org/10.2139/ssrn.1016112

Danling Jiang (Contact Author)

College of Business, Stony Brook University ( email )

306 Harriman Hall
Stony Brook, NY 11794
United States

HOME PAGE: http://sites.google.com/site/danlingjiang

David R. Peterson

Florida State University - Department of Finance ( email )

Tallahassee, FL 32306-1042
United States
850-644-8200 (Phone)
850-644-4225 (Fax)

James Doran

University of New South Wales ( email )

College Rd
Sydney, NSW 2052
Australia

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