Short Selling and the Price Discovery Process

Short Sales and Price Discovery in the Hong Kong Stock Market

“…The overall results indicate that short sales accelerate the speed of price adjustment by decreasing the autocorrelations in both quote returns and trades in addition events; these findings being consistent with those from Boehmer & Wu (2013), namely that short sales contribute to a more efficient process of price discovery with a smaller autocorrelations in quote returns which is more associated with a random walk. The study of parameter dynamics reports that there is a great consistency for the majority of model parameters; that is, parameters which, for example, are statistically significantly negative before an event tend to remain in that category after it.…”

“…They find that stocks have greater autocorrelations in quote returns and less trade continuity indicating a quicker speed of price adjustment when they are added to the short selling list. On the contrary, Boehmer & Wu (2013) argue that an efficient process of price discovery should follow a random walk in association with a smaller autocorrelations. They find that more shorting flows speed up the incorporation of new information into prices by weakening the autocorrelations in quote returns.…”

“…In addition, their model indicates that the prices of stocks without the eligibility of short sales will have a delayed speed of adjustment to unfavourable private information as short sellers' activities are limited in the market. Due to the lack of data and to difficulties in characterising the speed of price adjustment, only a few papers empirically test the prediction of Diamond & Verrecchia (1987), namely that short sales constraints slow down the process of price discovery (Beber & Pagano, 2013;Boehmer & Wu, 2013;Bris et al, 2007;Chang et al, 2014;Chen & Rhee, 2010;Saffi & Sigurdsson, 2010).…”

“…They find that shortable stocks have a faster speed of price adjustment to new information by exhibiting more negative autocorrelation in mid-quote returns and less positive trade continuity. Boehmer & Wu (2013) define the mid-quote return as the return on the mid-price for two successive quotations in the VAR model to capture price efficiency and they believe that an efficient price process should follow a random walk. Their results show that a greater shorting flow (that is, a larger number of short selling orders) is associated with smaller pricing errors and smaller mid-quote return autocorrelations, which indicate faster price discovery.…”

Explanations of Asset Price Bubbles

“…The former is often enforced by state regulation, which can be changed, and in the case of stocks several analyses call into question the social benefits of short selling constraints (Marsh -Payne 2012;Beber -Pagano 2013;Boehmer -Wu 2013). Some perverse incentives in the provision of information can be corrected effectively through more efficient regulation, and state organisations can complement the activities of market participants.…”