The dynamics of short sales constraints and market quality: An experimental approach

We test the effect of short sale constraints on market quality in an experimental setting. Short sale constrained securities trade at a premium, which is often higher than the difference between the view of the most optimistic investor and the fundamental value. Opinion dispersion contributes to overpricing; this result is more pronounced at the time opinion dispersion is induced. As time progresses, traders update their valuations with information from trading. Consequently, opinion dispersion narrows and its effect on overpricing dissipates. Under short sale constraints, the speed of price adjustment is slower, as prices never fully converge to their fundamental values. (c) 2020 Published by Elsevier B.V.

Automated summary

The study found that short sale constraints lead to securities trading at a premium, with opinion dispersion contributing to overpricing. As traders update their valuations over time, opinion dispersion decreases and the impact of overpricing diminishes. Prices under short sale constraints adjust slower and do not fully converge to their fundamental values.