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

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Listed:
  • Bai, Min
  • Li, Xiao-Ming
  • Qin, Yafeng

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.

Suggested Citation

  • Bai, Min & Li, Xiao-Ming & Qin, Yafeng, 2017. "Shortability and asset pricing model: Evidence from the Hong Kong stock market," Journal of Banking & Finance, Elsevier, vol. 85(C), pages 15-29.
  • Handle: RePEc:eee:jbfina:v:85:y:2017:i:c:p:15-29
    DOI: 10.1016/j.jbankfin.2017.08.007
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    References listed on IDEAS

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    Keywords

    Asset pricing models; Short-sales constraints; Shortability factor;

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets

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