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The impact of short-selling and margin-buying on liquidity: Evidence from the Chinese stock market

Xiaoyuan Wan

Journal of Empirical Finance, 2020, vol. 55, issue C, 104-118

Abstract: We propose a framework based on limit order book to analyze the impact of short-selling and margin-buying on liquidity. We show that when short-sellers are perceived as informed, adverse selection may lead to uninformed traders withdrawing their limit orders. Given that the Chinese stock market has strong information asymmetry and a high proportion of uninformed traders, we predict that the pilot program launched in March 2010, which lifts restrictions on short-selling and margin-buying for a designated list of stocks, may have a negative impact on liquidity. We perform difference-in-differences tests and show evidence that allowing for short-selling and margin-buying indeed has a significantly negative impact on liquidity for stocks on the designated list. In particular, the negative impact on liquidity is more pronounced for stocks with high information asymmetry. Nevertheless, when short-selling volume dries up due to regulation changes in August 2015, i.e., the “T+1” trading rule on short-selling, we show that consistent with model predictions, lifting restrictions on short-selling and margin-buying has a positive effect on liquidity.

Keywords: Short-selling; Margin-buying; Liquidity; Limit order book; Adverse selection; Information asymmetry (search for similar items in EconPapers)
JEL-codes: G12 G14 G15 G18 (search for similar items in EconPapers)
Date: 2020
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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:55:y:2020:i:c:p:104-118

DOI: 10.1016/j.jempfin.2019.11.003

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Journal of Empirical Finance is currently edited by R. T. Baillie, F. C. Palm, Th. J. Vermaelen and C. C. P. Wolff

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