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

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  • Hauser, Florian
  • Huber, Jürgen

Abstract

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.

Suggested Citation

  • Hauser, Florian & Huber, Jürgen, 2012. "Short-selling constraints as cause for price distortions: An experimental study," Journal of International Money and Finance, Elsevier, vol. 31(5), pages 1279-1298.
    • Handle: RePEc:eee:jimfin:v:31:y:2012:i:5:p:1279-1298
    DOI: 10.1016/j.jimonfin.2012.02.001
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    Cited by:

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    6. Fellner, Gerlinde & Theissen, Erik, 2014. "Short sale constraints, divergence of opinion and asset prices: Evidence from the laboratory," Journal of Economic Behavior & Organization, Elsevier, vol. 101(C), pages 113-127.

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    More about this item

    Keywords

    Experiment; Short-selling constraints; Overvaluation; Price distortions; Divergence of opinions;
    All these keywords.

    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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