The Loud Silence of Suppressed Short-Sale Demand

Abstract

Utilizing the special institutional setting in the Chinese securities market, we examine how suppressed short-sale demand influences stock valuations and price efficiency for stocks with no short-selling activities. Based on revealed short-sale volume of shortable stocks, we employ a characteristics model to estimate the suppressed short-sale demand for non-shortable stocks, with a higher short-sale demand being suppressed indicates a more binding short-sale constraint. We find that suppressed short-sale demand negatively predicts future returns, and such relation concentrates among firms with poor information environment. Consistent with Diamond and Verrecchia (1987)’s reduced-pricing-efficiency theory, we find that a higher suppressed short-sale demand is associated with a greater price delay and a stronger post-earnings-announcement-drift.

Keywords: Short-Sale Demand, Overvaluation, Price Efficiency, Chinese Market

JEL Classification: G12, G14, G18