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Short-selling constraints as cause for price distortions: An experimental study

  • Hauser, Florian
  • Huber, Jürgen
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    In this paper we explore the influence of the possibility to short stocks and/or borrow money in laboratory markets. A key innovation of our study is that subjects can simultaneously trade two risky assets on two double-auction markets, allowing us to differentiate between assets with relatively high versus low capitalization. Divergence of opinions is created by providing each trader with noisy information on the intrinsic values of both assets. We find that when borrowing money or shorting stocks is restricted prices are systematically distorted. Specifically, stocks with high (low) capitalization are traded at lower (higher) prices than their fundamental value. Lifting the restrictions leads to more efficient prices and more liquidity, thereby also lowering volatility and bid-ask spreads.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0261560612000332
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    Article provided by Elsevier in its journal Journal of International Money and Finance.

    Volume (Year): 31 (2012)
    Issue (Month): 5 ()
    Pages: 1279-1298

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    Handle: RePEc:eee:jimfin:v:31:y:2012:i:5:p:1279-1298
    Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30443

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