the university of hong kong short-sales constraints and price discovery: evidence from the hong kong...
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The University of Hong Kong
Short-Sales Constraints and Price Discovery:
Evidence from the Hong Kong Market
Eric C. CHANG and Yinghui YU
The University of Hong Kong
Presented by: Eric C. CHANG2004 NTU International Conference on Finance
2The University of Hong Kong
Introduction
• Objective
– Impact of short-sales constraints on pricing efficiency
• Price discovery
– Process of incorporating new information into asset prices
• Short-sales constraints (“SSC”)
– Asymmetric market friction
• Data from Hong Kong stock market, with unique short-sales restrictions
3The University of Hong Kong
Introduction (II)
• Diverse short-sales practice across markets In the period of Jan. 1990 -- Dec. 2001,– Allowed and practiced
• U.S., U.K., Australia, Austria, Belgium, Canada, Denmark, France, Germany, Ireland, Italy, Japan, Mexico, the Netherlands, Portugal, South Africa, Switzerland (19)
– Prohibited• Colombia, Greece, Indonesia, Singapore, South Korea (12)
– Allowed but rarely practiced• Argentina, Brazil, Chile, Finland, India, New Zealand, the
Philippines, Poland, Spain, Turkey (11)
– Regulation and practice changed• Hong Kong, Norway, Sweden, Malaysia, and Thailand (5)
----Bris, Goetzmann, Zhu (2003)
4The University of Hong Kong
Outline
• Theoretical background
• Existent empirical evidence
• Short Sales on Hong Kong Stock Market
• SSC and overvaluation
• SSC and distributions of stock returns
• Conclusions
5The University of Hong Kong
Theoretical Background
• Miller (1977)’s intuition: With short-sales constraints, security prices tend to reflect the most optimistic opinion and thus to be upward-biased
• Short sales prohibited or costly
• Heterogeneous expectation among investors
• Figlewski (1981), Chen, Hong, and Stein (2002)
• Jarrow (1980): Not necessarily upward-biased
• Diamond and Verrecchia (1987): No overpricing on average in a rational-expectation framework
6The University of Hong Kong
Existent Empirical Evidence
• Largely supports overvaluation
• Mostly indirect – Difficulty to quantify SSC
• Rebate rate • Frictions in lending market
• Tick rule • Short squeeze, etc.
• Bris, Goetzmann, Zhu (2003): Investigation across 47 countries
Assumptions in Measuring Short-Sales Constraints
Chen, Hong, and Stein
(2002)
The fewer shareholders, the more difficult to sell short
Danielsen and Sorescu (2001)
The availability of stock options can be regarded as being easier to sell short
Jones and Lamont
(2002)
Data are available between 1926 and 1933 showing that certain stocks are expensive to borrow
7The University of Hong Kong
Short Sales on Hong Kong Stock Market
• A short-sales designation list since 1994– Only stocks on the list can be sold short
– Revised quarterly based on liquidity and market capitalization criteria
– On-the-list event & off-the-list event
• Therefore, we expect our empirical test – Direct (No proxies for short-sales constraints needed)
– Market-level and firm-level factors well controlled
– Off-the-list events as a mirror test
8The University of Hong Kong
Effective Date Announcement
Date On-the-List Events
Off-the-List Events
Numbers of Stocks
on the List 3-Jan-94 N/A 17 0 17
25-Mar-96 7-Mar-96 96 0 113 1-May-97 29-Apr-97 129 0 241* 12-Jan-98 N/A 69 0 310 16-Mar-98 N/A 15 0 325 9-Nov-98 N/A 19 149 195 1-Mar-99 N/A 7 7 195 20-Sep-99 N/A 3 17 181 12-Nov-99 N/A 1 0 182 28-Feb-00 23-Feb-00 24 12 194 31-May-00 N/A 7 0 201 28-Aug-00 N/A 32 16 217 12-Feb-01 31-Jan-01 15 11 221 14-May-01 3-May-01 6 0 227 20-Aug-01 7-Aug-01 9 11 225 3-Dec-01 27-Nov-01 17 85 157 25-Feb-02 5-Feb-02 7 14 150 21-May-02 8-May-02 11 6 155 29-Jul-02 17-Jul-02 24 5 174 29-Nov-02 21-Nov-02 6 15 165 27-Jan-03 21-Jan-03 5 7 163
Cumulated: 519 355 448
9The University of Hong Kong
SSC and Overvaluation
• Hypotheses – Stock prices will decrease (increase) when short-sales restrictions
are repealed (reinstated).
– The overvaluation effect of short-sales constraints is positively associated with the extent of dispersion of opinions, i.e., the more diverse the opinions, the more stock prices will decrease when short-sales restrictions are repealed.
• Abnormal Return Measures– Market model – Market-adjusted model
2
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10The University of Hong Kong
Cumulated Abnormal Returns Around on-the-List Events
Variable Description Number of
Observations Mean Median Std. Dev. Min. Max.
ARm(0) 391 -0.00619 -0.00341 0.05030 -0.22355 0.22650 t-stat -2.43** CARm(0,5) 391 -0.02546 -0.00769 0.14478 -1.08932 0.53113 t-stat -3.48*** CARm(0,10) 391 -0.04524 -0.02154 0.17164 -0.91185 0.75878 t-stat -5.21*** CARm(0,15) 391 -0.05677 -0.03146 0.19959 -1.02121 0.76133 t-stat -5.62*** CARm(0,20) 391 -0.02154 -0.02458 0.18336 -0.60246 0.98045 t-stat -2.32** CARm(0,30) 391 -0.04648 -0.04519 0.23101 -1.01814 1.31484 t-stat -3.98***
11The University of Hong Kong
-0. 12
-0. 1
-0. 08
-0. 06
-0. 04
-0. 02
0
0. 02
-30 -25 -20 -15 -10 -5 0 5 10 15 20 25 30 35 40 45 50 55 60
Event day relative to event date
Abn
orm
al R
etur
n / C
umul
ativ
e A
bnor
mal
Ret
urn
ARs of on-the-List Events CARs of on-the-List Events
`
Cumulated Abnormal Returns Around on-the-List Events
Result 1: Stock prices decrease when short-sales restrictions are repealed, i.e. short-sales constraints tend to cause overvaluation
event day
12The University of Hong Kong
Tick Rule Effect
Result 1-2: Stock prices decrease more when short-sales constraints are repealed more thoroughly
Variable Description Number of
Observations Mean Median Std. Dev. Min. Max.
Panel A: Tick Rule Effective (total 179 events) ARm(0,0) 149 -0.00070 -0.00187 0.03587 -0.15334 0.10836 t-stat -0.24 CARm(0,5) 149 -0.00081 -0.00097 0.07301 -0.24093 0.20461 t-stat -0.14 CARm(0,10) 149 -0.02287 -0.02662 0.12575 -0.49815 0.42628 t-stat -2.22** Panel B: Tick Rule Repealed (total 271 events) ARm(0,0) 242 -0.00957 -0.00483 0.05722 -0.22355 0.22650 t-stat -2.60*** CARm(0,5) 242 -0.04063 -0.01696 0.17332 -1.08932 0.53113 t-stat -3.65*** CARm(0,10) 242 -0.05901 -0.01630 0.19356 -0.91185 0.75878
t-stat -4.74***
13The University of Hong Kong
Announcement Date or Effective Date?
• CARs Around Announcement Dates for on-the-List Events
Result 1-3: It suggests that price changes are triggered by short-sales restriction changes, not by the news of changes
Panel A: On-the-List Events (total 309 events)
Variable Description Number of
Observations Mean Median Std. Dev. Min. Max.
ARm(0,0) 267 0.00241 -0.00047 0.04027 -0.07887 0.32424 t-stat 0.98 CARm(0,1) 267 0.00156 -0.00257 0.05264 -0.17172 0.27962 t-stat 0.48 CARm(0,2) 267 -0.00614 -0.01279 0.06913 -0.24039 0.33772 t-stat -1.45
14The University of Hong Kong
What to Expect for off-the-List Events?
• Cumulated Abnormal Returns Around off-the-List Events
Variable Description Number of
Observations Mean Median Std. Dev. Min. Max.
ARm(0) 306 0.00686 0.00510 0.04922 -0.20128 0.30974
t-stat 2.44** CARm(-15,-1) 306 0.07995 0.03922 0.21874 -0.38878 1.27211 t-stat 6.39*** CARm(-10,-1) 306 0.05857 0.02370 0.16880 -0.39581 1.03514 t-stat 6.07*** CARm(-5,-1) 306 0.02998 0.00850 0.12389 -0.36733 0.92552 t-stat 4.23*** CARm(-10,10) 306 0.07666 0.03762 0.26646 -0.58785 1.34196 t-stat 5.03*** CARm(-10,20) 306 0.06261 0.03871 0.28453 -0.69502 1.32485 t-stat 3.85***
15The University of Hong Kong
-0. 02
0
0. 02
0. 04
0. 06
0. 08
0. 1
0. 12
0. 14
-30 -25 -20 -15 -10 -5 0 5 10 15 20 25 30 35 40 45 50 55 60
Event day relative to event date
Abn
orm
al R
etur
n / C
umul
ativ
e A
bnor
mal
Ret
urn
ARs of off-the-List Events CARs of off-the-List Events
`
Cumulated Abnormal Returns Around off-the-List Events
Mirror Result 1: Stock prices increase when short-sales restrictions are reinstated ---- Still, short-sales constraints are associated with overvaluation
event day
16The University of Hong Kong
Is It Announcement Effect?
• CARs Around Announcement Dates for off-the-List Events
• Mixture of Two Effects Suggested– Announcement of off-the-list events is immediately bad news
– Investors expect off-the-list events prevent future negative information from being impounded into the stock prices, and trade in advance.
Panel B: Off-the-List Events (total 149 events)
Variable Description Number of
Observations Mean Median Std. Dev. Min. Max.
ARm(0,0) 148 -0.00801 -0.00809 0.03254 -0.12409 0.14824 t-stat -3.00*** CARm(0,1) 148 -0.01914 -0.01729 0.04643 -0.15470 0.15191 t-stat -5.02*** CARm(0,2) 148 -0.01715 -0.01754 0.06322 -0.20664 0.16852 t-stat -3.30***
17The University of Hong Kong
Model Specification No. 1 2 3 4 5 6 7 8 9 10 Dependent Variable CARm CARm CARm CARm CARm CARa CARm CARm CARm CARm Intercept 0.0117 0.0044 -0.0107 -0.0435 0.0139 -0.0042 -0.0452 0.02623 0.02694 0.0067 (t= 0.81) (t=0.31) (t=-1.04) (t=-5.02)*** (t=0.80) (t=-0.25) (t=-5.17)*** (t=1.48) (t=1.50) (t=0.39) SIGMAraw -1.5167 -1.20709 (t= -4.80)*** (t=-3.16)*** SIGMAab -1.4295 -1.05113 (t=-4.29)*** (t=-2.77)*** TURNOVER -5.2426 -4.5575 (t= -5.65)*** (t=-4.25)*** ALPHA 4.09826 (t=2.09)** BETA -0.0721 -0.0529 -0.03208 -0.04372 -0.0269 (t=-3.86)*** (t=-2.89)*** (t=-1.43) (t=-2.06)** (t=-1.27) SSVOL 5.1777 (t=0.55) No. of Observations 390 390 390 390 390 390 390 390 390 390 Adjusted R-Square 0.0536 0.0428 0.0736 0.0086 0.0344 0.0185 -0.0018 0.0562 0.0508 0.0750
SSC, Overvaluation, and Dispersion of Opinions
• Cross-sectional regressions of CARs around on-the-list events over dispersion of opinions
Result 2: The more diverse the investors’ opinions, the more stock prices will decrease when short-sales restrictions are repealed
18The University of Hong Kong
SSC, Overvaluation, and Dispersion of Opinions (II)
• Tick Rule Effect
• Result 2-2: Dispersion of investors’ opinions is associated with more decrease in stock prices when short-sales constraints are repealed more thoroughly
Panel A: Tick Rule Effective (total 179 events) Model Specification No. 1 2 3 4
Dependent Variable CARm CARm CARm CARm
Intercept 0.01132 0.01160 -0.01018 -0.01467 (t=0.67) (t=0.71) (t=-0.80) (t=-0.74) SIGMAraw -0.72141 (t=-2.52)** SIGMAab -0.77971 (t=-2.69)*** TURNOVER -1.70222 (t=-1.67)* BETA -0.00942 (t=-0.48) No. of Observations 148 148 148 148 Adjusted R-Square 0.03510 0.04070 0.01210 -0.00530
Panel B: Tick Rule Repealed (total 271 events) 1 2 3 4
CARm CARm CARm CARm
0.09414 0.09334 -0.00588 0.05585 (t=4.03)*** (t=3.73)*** (t=-0.41) (t=2.15)**
-4.91680 (t=-7.43)***
-5.34018 (t=-6.81)*** -8.83462 (t=-6.31)*** -0.14563 (t=-4.94)***
242 242 242 242 0.18340 0.15840 0.13860 0.08870
19The University of Hong Kong
Model Specification No. 1 2 3 4 5 6 7 8 9 10 Dependent Variable CARm CARm CARm CARm CARm CARa CARm CARm CARm CARm
Intercept 0.0242 0.0298 0.0848 0.0425 0.0597 0.0343 0.0638 0.0256 0.0294 0.0704 (t=0.94) (t=1.19) (t=6.97)*** (t=3.77)*** (t=2.98)*** (t=1.87)* (t=6.06)*** (t=0.89) (t=1.02) (t=3.54)*** SIGMAraw 0.8453 0.8560 (t=1.67) (t=1.66)* SIGMAab 0.7518 0.7500 (t=1.46) (t=1.45) TURNOVER -4.8781 -5.1554 (t=-3.37)*** (t=-3.49)*** ALPHA -11.17034 (t=-4.32)*** BETA 0.0060 0.0130 -0.0034 0.0009 0.0278 (t=0.20) (t=0.47) (t=-0.11) (t=0.03) (t=0.91) SSVOL -0.8999 (t=-0.92) No. of Observations 306 306 306 306 306 306 306 306 306 306 Adjusted R-Square 0.0058 0.0037 0.0329 0.0548 -0.0032 -0.0026 -0.0005 0.0026 0.0004 0.0324
SSC, Overvaluation, and Dispersion of Opinions (III)
• Cross-Sectional Regressions of CARs Around off-the-List Events over Dispersion of Opinions
Mirror Result 2: Basically, it still holds that the more diverse opinions, the larger overvaluation effect of short-sales constraints
20The University of Hong Kong
SSC and Distributions of Stock Returns
• Skewness, volatility of returns, and market crashes (frequency of extreme negative returns)
Short Selling
Prohibited Short Selling
Allowed Difference
Mean Median Mean Median t-Statistics
p-Value of Sign Test
p-Value of Signed Rank Test
No. of Obs.
Panel A: On-the-List Events 353 Mean Raw Returns 0.0012 0.0010 -0.0006 -0.0003 7.46*** 0.0000 0.0000 Raw Returns 0.0369 0.0299 0.0415 0.0398 -2.89*** (0.0884) (0.0006)
Standard Deviation Abnormal Returns 0.0340 0.0286 0.0375 0.0361 -2.36** (0.0702) (0.0004)
Raw Returns 0.8698 0.7800 0.7083 0.6316 1.34 0.0040 0.0086
Skewness
Abnormal Returns 0.9392 0.8212 0.7812 0.6600 1.29 0.0105 0.0050
Return<Mean-2*Stdev 0.0201 0.0201 0.0200 0.0208 0.0200 -1.09 (0.0105)
Panel B: Off-the-List Events 202 Mean Raw Returns 0.0006 0.0002 -0.0006 -0.0010 2.63*** 0.0059 0.0075 Raw Returns 0.0436 0.0371 0.0467 0.0460 -0.76 (0.0000) (0.0000)
Standard Deviation Abnormal Returns 0.0424 0.0351 0.0449 0.0435 -0.60 (0.0000) (0.0000)
Raw Returns 1.0819 0.6566 0.2290 0.4115 4.99*** 0.0009 0.0000
Skewness
Abnormal Returns 1.1171 0.6964 0.2172 0.4212 5.15*** 0.0000 0.0000
Return<Mean-2*Stdev 0.0206 0.0200 0.0217 0.0200 -1.49 (0.7527)
21The University of Hong Kong
SSC and Distributions of Stock Returns (II)
Result 3: When short sales are allowed, stock returns exhibit higher volatility and less positive skewness, while no significant difference is observed in the frequency of extreme negative daily returns
22The University of Hong Kong
Conclusions and Future Research
• Conclusions
– Short-sales constraints tend to cause stock overvaluation
– The wider dispersion of investor opinions, the more dramatic the overvaluation
– When short sales are allowed, individual stock returns seem to exhibit higher volatility and less positive skewness
• Future Research
– Short-sales-constrained stocks respond more slowly to bad news than to good news?
– Market makers set wider bid-ask spreads to protect themselves?
– Tailored theoretical model
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