Costly and unprofitable speculation: evidence from trend-chasing Chinese short-sellers and margin-traders

Abstract

China launched a pilot scheme in March 2010 to lift the bans on short-selling and margin-trading for stocks on a designated list. We find that stocks experience negative returns when added to the list. After the bans are lifted, the return volatility increases, and pricing efficiency decreases in the up-market. Utilizing panel data on the daily short-selling and margin-trading volume, we surprisingly find that stocks that are heavily sold short earn higher future returns, whereas stocks that are heavily purchased on margin subsequently underperform. Chinese investors appear to trade strongly based on the technical analysis. We thus conclude that neither short-sellers nor margin-traders possess superior information or skill. We argue that short-sellers speculate in periods of high volatility following a wider divergence of opinion, whereas margin-traders speculate in periods of low volatility, which adds to return volatility and destabilize the market.