Short Selling ADRs and Foreign Market Short-Sale Constraints

Abstract

We examine the effect of home market short-sale constraints on stocks that also trade in other countries that have more liberal short-sale rules. We focus on the case of ADRs traded in the U.S., as in some cases, the home markets of these ADRs prohibit short selling. We find that U.S. short sellers more heavily trade ADRs from markets where short selling is prohibited than from markets where short selling is allowed. We also find that when short sellers trade these short-sale restricted ADRs, they behave in a contrarian manner consistent with them being able to exploit and profit from private information. Further, ADR short sellers are able to predict negative returns regardless of the severity of the home-market short-sale constraints and that return predictability of ADR short sellers is greater for ADRs of foreign stocks with binding home-market constraints. Our study brings into question the efficacy and economic sense of local market short-sale restrictions for stocks that trade globally.