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.