Short-sales constraints and liquidity change: Cross-sectional evidence from the Hong Kong Market

Abstract

This study investigates the impact of short-sales constraints on liquidity for individual stocks in Hong Kong, as the Hong Kong Stock Market has a special feature such that, at each point of time, only a subset of stocks are allowed to be sold short, with the list of these stocks changing over time. We find that the impact is heterogeneous across stocks: Following the repealing of short-sales constraints, only large, illiquid and inactively traded firms increase in liquidity; while others significantly drop in prices and liquidity. Following the imposing of short-sales constraints, only inactively traded stocks significantly increase in liquidity and prices. The heterogeneous liquidity change also affects the relation between stock overvaluation and one of its necessary conditions — dispersion of investor opinions. When stocks are allowed to be sold short, such a relation is stronger for firms with deteriorating liquidity. When stocks are prohibited from being sold short, this relation disappears among firms with deteriorating liquidity.