Short-selling, margin-trading and price efficiency: evidence from the Chinese market

Abstract

China launched a pilot scheme in March 2010 to lift the bans on short-selling and margin-trading for stocks on a designated list. We find that stocks experience negative returns when added to the list. After the bans are lifted, price efficiency increases while stock return volatility decreases. Using panel data, we find higher price efficiency to be associated with intensified short-selling activities. Short-sellers trade to eliminate overpricing by selling stocks with positive contemporaneous returns following a downward trend, while margin-traders tend to buy stocks with negative contemporaneous returns and/or with strong sell-order imbalance. We further show that short-sellers do possess return predictive power, while margin traders do no have such an ability.