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

Abstract

Short-sales practices in the Hong Kong stock market are unique in that only stocks on a list of designated securities can be sold short. By analyzing the price effects following the addition of individual stocks to the list, we find that short-sales constraints tend to cause stock overvaluation and that the overvaluation effect is more dramatic for individual stocks for which wider dispersion of investor opinions exists. These findings are consistent with Miller's (1977) intuition and other optimism models. We also document higher volatility and less positive skewness of individual stock returns when short sales are allowed. Copyright 2007 by The American Finance Association.

The impact of naked short selling on the securities lending and equity market

“…6 Chang, Chang, and Yu (2007) offer the only direct examination (without the need for a proxy) of the relationship between covered short sale constraints and stock price overvaluation on the Hong Kong Stock Exchange (HKEx). Consistent with Miller (1977), significant negative cumulative abnormal returns are reported after stocks are added to the list of designated securities for covered short sales.…”

“…Ho (1996) documents that the daily volatility of stock returns increases when short sale constraints are imposed. Chang, Chang, and Yu (2007) however, using a direct measure of short sale constraints, find the volatility of stock returns increases when the constraints are lifted. 7 Consistently, Henry and McKenzie (2006) find that the Hong Kong market exhibits greater volatility following a period of short selling and that volatility asymmetry is exacerbated by short selling.…”

“…To test this hypothesis, we examine cumulative abnormal returns (CARs) around the effective date for additions to the list of eligible stocks. Consistent with previous literature (Danielsen and Sorescu, 2001;Chang, Chang, and Yu, 2007), effective dates rather than announcement dates are used as they represent the actual removal of short sale constraints. Further, announcement dates are not available and discussions with exchange officials indicate changes are announced either on the effective date or 1-2 trading days in advance.…”

“…The literature examines changes in the rules governing either covered short sales (Chang, Chang, and Yu, 2007), or changes to short sale constraints that affect both naked and covered short sales (Boehme, Danielsen, and Sorescu, 2006). The purpose of this paper is to bridge this gap in the literature by directly examining the impact of allowing naked short selling on returns, volatility, and liquidity.…”

Short interest in exchange-traded funds

“…They suggest that the short interest level in the Canadian market may be a more effective indicator than the same would be in the US market because of fewer short-selling restrictions in the Canadian market. Chang et al (2007) assess short-selling conditions in Hong Kong and find that short-selling constraints cause a greater degree of overreaction of individual stocks.…”