Does Unconstrained Short Selling Result in Unbiased Security Prices? Evidence from the Weekend Effect in Futures Markets

Abstract

Theoretical predictions and empirical results are ambiguous about the effect of short sale constraints on security prices. Since these constraints cannot be eliminated in equity markets, we use trades from futures markets where there is no distinction between short and long positions. We find that even with frictionless short selling, there is an upward bias in prices around weekends. The bias is stronger in periods of high volatility when short sellers are unwilling to accept higher levels of risk. On the other hand, riskiness of long positions does not seem to have a similar impact on prices. Thus, evidence in the paper shows that security prices may be biased upwards even without constraints on short selling due to asymmetric risk of short and long and positions.