(The) effects of shortsales on stock market efficiency and volatility

Abstract

Much standard analysis in finance is based on the assumption that shortsales is allowed in the stock market. In addition, issues related to stock market efficiency and volatility have received special attention over the years. Motivated by the observation of particular events, that is, the prohibition and the subsequent resurrection of shortsales in Korean stock market, we investigate the effect of shortsales on stock market efficiency and volatility. Typically, stock market efficiency is decomposed into two dimensions, dynamic and static efficiency, and the effects of shortsales are investigated separately for each dimension. From these investigations we propose a hypothesis about the effects of short-sales on stock market efficiency and volatility and test it using GARCH and BVAR models with time-series data for stock returns in Korean stock market. The two events are found to have some influence on dynamic efficiency of the stock market. Their impact on stock market volatility, however, is found to be insignificant or negligable from a statistical point of view. The effect of them on static efficiency of the stock market is left for future research. As proposed in the hypothesis, their effect on static efficiency may have offsetting impact, against their effect on dynamic efficiency, on stock market volatility.