Short-sale constraints and the idiosyncratic volatility puzzle: An event study approach |
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| Institution: | 1. College of Business, Florida State University, United States;2. Implied Capital Advisors, United States;1. The Chinese University of Hong Kong, Hong Kong;2. Rotman School of Management at the University of Toronto, Canada; Southwestern University of Finance and Economics, China;1. Department of Finance, Erasmus School of Economics, Erasmus University Rotterdam, 3000 DR Rotterdam, The Netherlands;2. Quantitative Strategies, Robeco, Coolsingel 120, 3011 AG, Rotterdam, The Netherlands;3. Econometric Institute, Erasmus School of Economics, Erasmus University Rotterdam, 3000 DR Rotterdam, The Netherlands;4. Expert Centre for Risk and Asset and Liability Management, Pension Fund Supervision, De Nederlandse Bank, P.O. Box 98, 1000 AB, Amsterdam, The Netherlands |
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| Abstract: | Using three natural experiments, we test the hypothesis that investor overconfidence produces overpricing of high idiosyncratic volatility stocks in the presence of binding short-sale constraints. We study three events: IPO lockup expirations, option introductions, and the 2008 short-sale ban on financial firms. Consistent with our prediction, we show that when short-sale constraints are relaxed, event stocks with high idiosyncratic volatility tend to experience greater price reductions, as well as larger increases in trading volume and short interest, than those with low idiosyncratic volatility. These results hold when we benchmark event stocks with non-event stocks with comparable idiosyncratic volatility. Overall, our findings suggest that biased investor beliefs and binding short-sale constraints contribute to idiosyncratic volatility overpricing. |
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