The effect of margin-trading and short-selling mechanism on left-tail risk: Evidence from a quasi-natural experiment in China

Abstract

This research investigates the influence of a margin-trading and short-selling pilot program on the left-tail risk of equities, utilizing A-share stock data in China from January 2004 to July 2020 as a sample. By exploiting the staggered implementation of the pilot program within a difference-in-differences framework, we examine the impact of margin-trading and short-selling mechanism on left-tail risks of equities in China. Firstly, we present empirical evidence that the introduction of margin-trading and short-selling mechanism can significantly mitigate the left-tail risk for the designated stocks. In particular, the effect is mainly from short-selling activities. Secondly, the empirical evidence suggests that the presence of information asymmetry among investors plays a mediating role in the mitigating impact. Thirdly, the findings demonstrate that mitigating effect of the mechanism is particularly pronounced during periods characterized by high investor sentiment and high levels of economic policy uncertainty. Additionally, results are robust to DID models when shell value contamination is removed, an alternative time period and measure of left-tail risk are considered, and placebo tests are conducted.