Market Efficiency, Short Sales Costs & Constraints, and Trading Volume; A Structural Approach

37 Pages Posted: 19 Jul 2017 Last revised: 30 Sep 2019

See all articles by Rajeev R. Bhattacharya

Rajeev R. Bhattacharya

Washington Finance and Economics; Johns Hopkins University

Date Written: September 29, 2019


I use eight different metrics as separate negative measures of the efficiency of the market for a security. I develop a theory of trading volume of a security as a function of short sales costs, etc., and market efficiency as a function of trading volume, etc. I identify appropriate instruments for the endogenous variables and for the variables that are measured with error, and I use Three-Stage Least Squares to estimate this two-equation structural model, separately for Nasdaq and non-Nasdaq U.S. stocks. Accounting for Fama-French Factors and institutional ownership, I find, contrary to much previous theoretical and empirical work, that the impact on market efficiency of short sales costs & constraints is not significantly negative and the impact on market efficiency of trading volume is not significantly positive, and my results are robust to various econometric specifications and financial economic assumptions.

Keywords: Event Study; Earnings Announcements; Key Developments; Arbitrage Risk; Idiosyncratic Risk; Investor Dispersion; Transaction Costs; Market Makers; Analysts; Market Capitalization; Book to Market Ratio; Price/Earnings; Leverage; Fama-French Factors; Institutional Ownership

JEL Classification: G14; G12; C58; C33; C36

Suggested Citation

Bhattacharya, Rajeev, Market Efficiency, Short Sales Costs & Constraints, and Trading Volume; A Structural Approach (September 29, 2019). Available at SSRN: or

Rajeev Bhattacharya (Contact Author)

Washington Finance and Economics ( email )

United States


Johns Hopkins University

1717 Massachusetts Avenue, NW
Washington, DC 20036
United States

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