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Informed Trading with a Short-Sale Prohibition

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  • Stephen L. Lenkey

    (Smeal College of Business, Pennsylvania State University, University Park, Pennsylvania 16802)

Abstract

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.

Suggested Citation

  • Stephen L. Lenkey, 2021. "Informed Trading with a Short-Sale Prohibition," Management Science, INFORMS, vol. 67(3), pages 1803-1824, March.
    • Handle: RePEc:inm:ormnsc:v:67:y:2021:i:3:p:1803-1824
    DOI: 10.1287/mnsc.2019.3501
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    References listed on IDEAS

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    Cited by:

    1. Fohlin, Caroline & Lu, Zhikun & Zhou, Nan, 2022. "Short sale bans may improve market quality during crises: New evidence from the 2020 Covid," SAFE Working Paper Series 365, Leibniz Institute for Financial Research SAFE.
    2. Deng, Jun & Pan, Huifeng & Yan, Hongjun & Yang, Liyan, 2024. "Disclosing and cooling-off: An analysis of insider trading rules," Journal of Financial Economics, Elsevier, vol. 160(C).

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