Short Sales and Price Discovery in the Hong Kong Real Estate Market

Abstract

Indirect real estate (IRE) returns are often shown to lead direct real estate (DRE) returns. Apart from differences in liquidity, transaction costs, and management skills, the DRE market is also less complete than the IRE market-when negative shocks arrive, one can only short IRE (e.g., real estate stocks or REITs), but not DRE. This study investigates if short sales in the IRE market convey any information to the DRE market. Based on high-frequency (weekly) property price data in Hong Kong from 2000 to 2012, we find that short sales in the IRE market led DRE returns, even after controlling for the lagged IRE returns in a VAR model. This supports an information spillover mechanism in which the DRE market learns private information that is not reflected in IRE returns. The spillover effect, however, weakened after the recent global financial crisis because the increased uncertainty over the credibility of individual firms made short sales more reflective of firm-specific information than real estate market fundamentals.A short sale is the sale of a security not owned by the seller. A typical process is that the short seller borrows a security from a lender, sells it, and then repurchases and returns it to the lender. This works for stocks, but not real estate-a key point on which this paper is based. 1 Note that short sales here do not refer to the sale of property where the sale proceeds fall short of the outstanding loan balance.Previous research on short selling focused on the financial market. It aimed to answer: (1) whether short sellers possess private information and (2) whether short sale constraints cause stock overvaluation. For the first issue, several studies showed that short interest predicted future returns. Senchack and

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