Short-sales constraints and liquidity change: Cross-sectional evidence from the Hong Kong Market

This study investigates the impact of short-sales constraints on liquidity for individual stocks in Hong Kong, as the Hong Kong Stock Market has a special feature such that, at each point of time, only a subset of stocks are allowed to be sold short, with the list of these stocks changing over time. We find that the impact is heterogeneous across stocks: Following the repealing of short-sales constraints, only large, illiquid and inactively traded firms increase in liquidity; while others significantly drop in prices and liquidity. Following the imposing of short-sales constraints, only inactively traded stocks significantly increase in liquidity and prices. The heterogeneous liquidity change also affects the relation between stock overvaluation and one of its necessary conditions - dispersion of investor opinions. When stocks are allowed to be sold short, such a relation is stronger for firms with deteriorating liquidity. When stocks are prohibited from being sold short, this relation disappears among firms with deteriorating liquidity. (C) 2013 Elsevier B.V. All rights reserved.