Abstract
We investigate the effect of short selling constraints on stock prices and corporate investment. We use as source of identification countries that adopted new regulations to permit short selling for the first time. We find that stock prices drop and price efficiency increases after the rule change. Corporate investment also drops, and capital allocation efficiency increases. Investment drops proportionately to the drop in overvaluation brought about by the rule change. Our results suggest that short selling constraints have a causal effect on the level and efficiency of stock prices and level and efficiency of corporate investment.
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