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Shortability and asset pricing model: Evidence from the Hong Kong stock market

Min Bai, Xiao-Ming Li () and Yafeng Qin ()

Journal of Banking & Finance, 2017, vol. 85, issue C, 15-29

Abstract: This study explores how the violation of free short selling assumption affects the performance of CAPM and the Fama-French three-factor model, as existing studies show that short-sales constraints affect asset pricing of the stocks. Using data from the Hong Kong Stock Market which has unique regulations on short selling, we conduct both time-series and cross-sectional regression analyses to evaluate the performance of the two models under the short-sales-constraints and the no-constraints market environment. The two models perform much worse in the former environment than in the latter, indicating a significant impact of the short sales constraints on the explanatory power of the models. We then augment the two models with a shortability-mimicking factor. Our results show that the factor has a significant power in explaining both time-series and cross-sectional variation in the size-B/M portfolio returns. The addition of the factor to the two models considerably increases their overall performance.

Keywords: Asset pricing models; Short-sales constraints; Shortability factor (search for similar items in EconPapers)
JEL-codes: G1 (search for similar items in EconPapers)
Date: 2017
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Handle: RePEc:eee:jbfina:v:85:y:2017:i:c:p:15-29