How Price Limit Affects the Market Efficiency in a Short-Sale Constrained Market? Evidence from a Quasi-Natural Experiment

In this paper, we extend the model in Diamond and Verrecchia (1987) by incorporating the effect of price limit and argue that the removal of short-sale constraints could synergize with price limit relaxation to speed up the price discovery. We show that the exogenous relaxation of price limit improves the price efficiency. Importantly, shortable stocks experience more improvement in price efficiency than non-shortable stocks. Event study analysis documents a more profound price reversal following the price limit hitting event on shortable stocks, which is explained by selling pressure from large institutional orders. Further evidence finds that only non-shortable stocks experience surged price volatility and investors speculation, and crowd-out of institutional ownership. Our findings suggest that alleviated short-sale constraints could synergize with trading restrictions relaxation to improve price efficiency