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

Authors

  • ERIC C. CHANG,

  • JOSEPH W. CHENG,

  • YINGHUI YU

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    • Eric C. Chang and Yinghui Yu are at the University of Hong Kong. Joseph W. Cheng is at the Chinese University of Hong Kong. ‘Eric C. Chang acknowledges financial support from the Research Grants Council of the Hong Kong Government (Earmarked Grant: HKU7656/05H, HKU7403/06H) and the Area of Excellence Scheme funded by RGC (AoE7sol;H-05/99). We would like to thank Rob Stambaugh, Michael Pinegar, and anonymous referee for helpful insights and suggestions. We also thank Clemens Sialm and seminar participants at the 2004 European Financial Association Conference and the 2004 NTU International Finance Conference, Taiwan.’

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.

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