Effects of Spot Market Short-Sale Constraints on Index Futures Trading

Abstract

We analyze the effects of spot market short-sale constraints on derivatives trading using a unique Chinese stock market futures trading database. Due to short-sale constraints, investors’ pessimistic views on the underlying index can be expressed solely through short futures positions, while investors’ optimistic views are dispersed through their spot and futures trading. We hypothesize that trading of pessimistic investors (with net short futures positions) contains more information than that of optimistic investors. We document the negative volatility–volume relation is associated with pessimistic investors’ trading, which attenuates with less-restricted spot market short-sale rules. Large pessimistic investors’ net demand can predict future returns, but not the case for optimistic investors.