Kaiguo Zhou Sun Yat-sen University, Guangzhou, China Michael C S Wong City University of Hong Kong, Hong Kong, China The Impact of Short Selling on China Stock Prices

Reading Questions When were short selling of stocks permitted in China stock market? How many stocks are permitted to be short sold? What methodology is used to study the impact of short selling on stock prices? What is the null hypothesis in the empirical study? What is the empirical result in this study? What is the implications of the empirical results in China stock market?

Background of Short Selling in China Before March 31, 2010, short selling had always been prohibited in Chinese stock market. On March 30, 2010, China Securities Regulation Committee (CSRC) formally announced the permit of margin purchase and short selling. CSRC approved a total of 90 selected stocks in Shanghai and Shenzhen exchanges for the trial run of the new reform. Short selling started on March 31, 2010.

Methodology Event Study Method The relationship between the returns of a stock and the market is estimated with the 60-day data before the event date. Then Beta coefficient is estimated. R j, t-h = a + b R m, t-h + e j, t-h, where h = 1 to 60 After the event date (t), abnormal return of Stock j at date t+k is estimated by AR j,t+k = R j,t+k – [a + b R m,t+k ], where k = 1 to 20 Cumulative abnormal return of Stock j at date t+k (CAR j,t+k ) is obtained by CAR j,t+k = AR j,t+1 + AR j,t+2 +… AR j,t+k The t-test is used to test whether the AR and CAR are significantly different from zero.

Test Group and Control Group Top 30 stocks allowed for short selling in terms of market capitalization are selected to form the test group. Correspondingly, 30 stocks not allowed for short selling are selected to form the control group.

Null Hypothesis The null hypothesis is that short selling does not affect stock prices. That is, Average AR j, t+k of the test group should be equal to 0. Average CAR j, t+k of the test group should be equal to 0. The line of the CAR of the test group should be flat. There should be no difference between the test group and control group in terms of above stock returns.

Empirical Results The test group shows negative abnormal return, while the control group does not. The cumulative abnormal return for the test group is significantly negative. The CAR for the control group are not significantly different from zero. The CAR line for the test group is deeply downward sloping, but no apparent upward or downward sloping trend is found for the control group.

Empirical Results The trend of CAR within the test window for the test group

Empirical Results The trend of the CAR of both the Test Group and the Control Group It shows that the CAR of the test group is significantly lower than that of the control group.

Conclusion Stocks allowed for short selling tend to have worse performance than those not allowed for short selling. The allowance of short selling can make stock price lower. Short selling provides a tool for informed investors to correct overpricing. In the long run, this may mitigate the occurrence of stock market bubble.