Relaxation of Short-sale Constraints and Security Prices: An Alternative Perspective

The relaxation of short-sale constraints allows investors not only to trade on over-pricing, but also to hedge their long positions in seemingly under-priced securities. Utilizing the institutional feature in Hong Kong that only stocks on a special list can be shorted, we provide evidence that the addition of a stock to the list invites participation of informed long-short investors and leads to strong positive abnormal returns among seemingly undervalued industry peers. Relatedly, positive earnings surprises in less-difficult-to-short industries, generally, are followed by a more immediate price reaction and, consequently, smaller post-earnings-announcement drift.

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