Short selling restrictions and market completeness: the Malaysian experience

Asjeet Lamba and Mohamed Ariff ()

Applied Financial Economics, 2006, vol. 16, issue 5, 385-393

Abstract: We examine the market's reaction around a series of events on the Kuala Lumpur Stock Exchange (KLSE) where the Malaysian government removed short selling restrictions on selected stocks and then subsequently reimposed these restrictions. These events provide a unique opportunity to analyse the effects of short selling restrictions on the price formation process in an emerging market. It has been argued that the impact on prices from incorporating negative information via short sales should lead to a correction of the upward bias in prices prevalent under short selling restrictions. This should result in lower prices and observed returns around the announcement of the removal of short selling restrictions. Conversely, it can be argued that the removal of these restrictions helps complete markets, permitting full price discovery. This is particularly important in a market like Malaysia where stock options are not traded. Here the immediate impact of a removal of short selling restrictions would be an upward revision in security prices resulting in positive observed returns. The opposite revaluation effects should hold in the situation when short selling restrictions are reimposed. We find evidence consistent with the explanation that the removal of short selling restrictions results in more complete markets and is valued by market participants, particularly for actively traded stocks.

Date: 2006
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DOI: 10.1080/09603100500396619

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