Previous studies on short selling have focused on how investors use information to drive trades. The work highlighted today, from Lixin (Nancy) Su (et al.) of the Hong Kong Polytechnic School of Accounting and Finance, looks instead at the mechanisms that drives that information acquisition.
The team looked at events in the U.S. and China that presented natural experiments when short-selling constraints were relaxed to see if and how those events stimulated greater investor investigative effort.
They set out to test two hypotheses.
The first they call the Direct Trading Effect. When short selling constraints are reduced investors have a new way to make money from information so the demand for information acquisition should be stimulated.
The second is what they call the Indirect Feedback Effect. It might be the case that in the absence of short selling investors are more motivated to find information when this mechanism isn’t in operation and thus efforts would be stimulated when short selling isn’t possible?
Notwithstanding the second hypothesis, what the study found, in both markets, was clear evidence that short selling improves market information. Bad news in particular is discovered more reliably however the magnitude of the effect of this discovery fades over time. Which is not to say it goes away.
Before getting to their final conclusion they make this useful observation; “.., our study suggests that capital market regulators should be cautious when introducing polices to ban short sales in crisis periods, since the ban could inhibit the production of total information and thus magnify the crisis..” Let’s see if regulators take note the next time this issue comes around?
The paper’s overall conclusion is timeless “..a reduction in trading frictions promotes information acquisition and improves price efficiency.” Which market folk know to be a self-evident truth. Regulators though, always and everywhere, seem somehow to wrestle with the concept.
You can access the work via this link Do Short-Sale Constraints Inhibit Information Acquisition?
Happy Sunday.