Short-Sales Constraints and Price Discovery: Evidence from the Hong Kong Market

Abstract

The unique short-sales restrictions present in the Hong Kong stock market, where a list of designated securities that can be sold short is revised from time to time, provide valuable data for examining the effects of short-sales constraints on market efficiency, especially efficiency in price discovery. By analyzing the cumulative abnormal returns around the lifting and reinstatement of short-sales restrictions, we find that short-sales constraints tend to cause stock overvaluation and that the overvaluation effect is more dramatic for individual stocks where wider dispersion of investor opinions exist. The evidence suggests that eliminating short-sales restrictions helps improve the efficiency of price discovery, which is consistent with Miller (1977)'s intuition. We also find that when short sales are allowed, individual stock return exhibits higher volatility and less positive skewness.

Keywords: Short-sales constraints, Price discovery, Hong Kong