Chapter 17 - Impact of Short Selling on China Stock Prices

Abstract

This chapter investigates the impact of short selling on China stock prices. It is generally argued that investors engage in short selling because of their belief that assets are overpriced. Some sell short simply to hedge against the risk of their current asset holdings. In this case, their hedges may be perfect hedges in which assets being short are the same as assets being held. In addition, some hedges may be imperfect hedges in which assets short and assets held are not the same. Before March 31, 2010, short selling was prohibited in the Chinese stock market as their regulators worried that short selling would exacerbate market volatility and cause severe instability to the stock market. On March 30, 2010, the China Securities Regulation Committee (CSRC) formally announced the permit of margin purchase and short selling. The CSRC approved a total of 90 selected stocks on the Shanghai and Shenzhen exchanges for a trial run of the new reform. The reform provided with a new data set for studying the impact of short selling on stock prices. An event study methodology and use of a control group for comparison, found that stocks allowed for short selling tend to have worse performance than those not allowed for short selling. This may support the arguments that short selling provides a tool to informed investors to correct overpricing and that short selling helps mitigate the occurrence of a stock market bubble.