Short‐sale constraints and informational efficiency to private information: A natural experiment

Hae Mi Choi

The Financial Review, 2020, vol. 55, issue 4, 625-643

Abstract: Exploiting a regulatory change in short‐sale constraints (Regulation SHO) as a natural experiment, this paper examines the effect of short‐sale constraints on informational efficiency of stock prices to private information. I find that short‐sellers act as informed traders prior to forthcoming analyst news and trade on negative private information. When short‐sale constraints are relaxed for pilot stocks (treatment group), both trading volume and stock price sensitivity increase prior to the analyst announcement for bad news but not for good news, relative to that of nonpilot stocks (control group). The findings are consistent with the Diamond and Verrecchia model that predicts that short‐selling increases the speed of adjustment of stock prices to private negative information. In the cross‐section, the effect of Reg SHO is stronger in stocks of firms with weak and uncertain information environments (i.e., small firms and firms with high analyst forecast dispersion).

Date: 2020
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