Reduction of Constraints on Arbitrage Trading and Market Efficiency: An Examination of Ex-Day Returns in Hong Kong after Introduction of Electronic Settlement

Previous research documents positive ex-dividend day returns in excess of one percent in the unique institutional setting of Hong Kong, where neither dividends nor capital gains are taxed. Short-term arbitrage trades around the ex-day were hampered by physical settlement procedures. After the recent switch to an electronic settlement system, which enables such trades, ex-day abnormal returns have declined to an insignificant 0.17 percent. This drop is more pronounced for high-yield stocks, which are more likely to attract dividend capture trading. The evidence points to the crucial role of short-term traders in ensuring the pricing efficiency of financial markets. Copyright The American Finance Association 2000.