The No-Short Return Premium

Nice academic paper. What's the return premium of short-sale restrictions:

Authors: Jiang, Li

Title: The No-Short Return Premium



Theory predicts that securities with greater limits to arbitrage are more subject to mispricing and thus should command a higher return premium. We test this prediction using the unique regulatory setting from the Hong Kong stock market, in which some stocks can be sold short and others cannot. We show that no-short stocks on average earn significantly higher returns than shortable stocks and the two groups of stocks tend to comove negatively. Moreover, stocks that comove more with the portfolio of no-short stocks on average earn higher subsequent abnormal returns while those comoving more with the shortable stocks earn lower subsequent abnormal returns. New additions to and deletions from the shorting list only partially contribute to the no-short return premium.

Notable quotations from the academic research paper:

"We test the existence of a mispricing return premium associated with a specific form of limits to arbitrage, short-sale restrictions, using a unique regulatory setting from the Hong Kong stock market. In the Stock Exchange of Hong Kong, short-sale restrictions apply to a subset of stocks but not the others. Stocks can be added to or deleted from the shorting list over time among the pool of stocks satisfying the criteria based on market capitalization, liquidity and so on. Thus, we can test whether the no-short stocks, presumably more subject to mispricing, earn a return premium relative to the shortable stocks. We do so by controlling for factor exposures and firm characteristics potentially correlated with the shorting list selections or expected stock returns.

Over the sample period 1997-2014, we find that no-short stocks on average earn a higher monthly return of 2%, or a higher abnormal monthly return of 1.32%, than shortable stocks. We term the return spread between the no-short and shortable stocks the no-short (NMS; no-short minus shortable) factor. The no-short factor premium estimate is consistently positive and statistically significant, robust to the adjustment for firm size, liquidity, and exposures to common factors such as the Fama and French (2015) five factors and the Hou, Xue, and Zhang (2015) four factors.

The strong predictive power of the NMS factor loadings extends to the full cross-section of individual stock returns, even in the presence of controls for firm size and book-to-market equity as well as a host of other firm characteristic variables. In other words, stocks that comove more with no-short stocks are expected to earn higher returns. Our interpretation is that these stocks embed higher risk of mispricing, and therefore command higher expected returns.

Lastly, we consider an alternative, although non-mutually exclusive, explanation for our finding of the positive no-short return premium. Shortable stocks may underperform no-short stocks simply because newly established short positions exert a downward price pressure on these stocks when they become shortable. As shortable stocks may be added to and deleted from the shorting list constantly, newly shortable stocks earn average lower returns when short positions are being introduced and newly no-short stocks earn higher returns when short position are being unwinded. To test this alternative hypothesis, we exclude stock-months within a 12-month window from when stocks are added to or deleted from the shorting list. We find that these exclusions do not alter our baseline finding of the positive no-short return premium. Thus, shortable stocks underperform no-short stocks not solely during periods of introduction or removal of the shortable status."

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