Informed Trading with a Short-Sale Prohibition

Using a rational expectations equilibrium framework, I evaluate the effects of a short-sale prohibition in an economy with asymmetrically informed investors who are identical except for their information sets. Relative to an economy in which short selling is permitted, the financial market is less i...

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Bibliographic Details
Published in:Management science 2021-03, Vol.67 (3), p.1803-1824
Main Author: Lenkey, Stephen L.
Format: Article
Language:English
Subjects:
asymmetric information
Auctions
Financial institutions
Financial market
Investors
Management
markets
Prohibition
Rational expectations
Restrictions
Short sales
Short selling
Trading
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Summary:Using a rational expectations equilibrium framework, I evaluate the effects of a short-sale prohibition in an economy with asymmetrically informed investors who are identical except for their information sets. Relative to an economy in which short selling is permitted, the financial market is less informationally efficient under a short-sale ban even when the ban is not binding. This alters the risk-sharing environment and leads to an increase in information acquisition. Additionally, a short-sale prohibition increases market depth. Imposing a cost on short selling instead of a strict prohibition yields similar results. Novel empirical implications are identified. This paper was accepted by Karl Diether, finance.
ISSN:0025-1909
1526-5501
DOI:10.1287/mnsc.2019.3501