Options, Short-Sale Constraints and Market Efficiency: A New Perspective

48 Pages Posted: 16 Sep 2010

Date Written: September 14, 2010

Abstract

This paper undertakes a new investigation of the potential for options to mitigate short-sale constraints. I find that option introduction alleviates 79% of the price adjustment efficiency disparity between short-sale constrained and unconstrained stocks in relation to negative news. No significant improvement in adjustment efficiency is found in response to positive information. These results are robust to controls for endogeneity biases associated with the option introduction selection process. Further, I find evidence that post-option improvement in efficiency is similar in relation to private and public information. This suggests that short-sale constraint effects stem, at least in part, from an irrational, optimism bias or another behavioral source as suggested theoretically by Miller (1977). Collectively, these results suggest that options act as an effective substitute to short-sales, significantly contributing to the informational efficiency of the market.

Keywords: Short-sale constraints, Option listing, Market efficiency

JEL Classification: G12, G14

Suggested Citation

Phillips, Blake, Options, Short-Sale Constraints and Market Efficiency: A New Perspective (September 14, 2010). Journal of Banking and Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1676997

Blake Phillips (Contact Author)

University of Waterloo ( email )

200 University Avenue West
Waterloo, Ontario N2L 3G1 N2L 3G1
Canada

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