Manacled short sellers and return premium: New evidence

Investigating the short-selling regulation of the Hong Kong market, we document that shortable stocks, on average, earn significantly higher returns than non-shortable stocks. However, loadings of stocks/portfolios on the shortable minus non-shortable misvaluation factor SMN predict a significant negative return premium in the cross-section of returns. We measure SMN by applying both value- and return-weighted methods with various time lags. We propose a behavioural model to rationalize our results. The model shows that, if investors are overconfident regarding short-selling regulatory factor signals, it is possible to detect a positive average/abnormal return but a negative future return premium on SMN.