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The Effect of Short Sale Constraint Removal on Volatility in the Presence of Heterogeneous Beliefs *
Author(s) -
Kraus Alan,
Rubin Amir
Publication year - 2003
Publication title -
international review of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.489
H-Index - 18
eISSN - 1468-2443
pISSN - 1369-412X
DOI - 10.1111/j.1468-2443.2005.00047.x
Subject(s) - volatility (finance) , economics , intuition , econometrics , stochastic game , stock market , stock (firearms) , financial economics , microeconomics , mechanical engineering , paleontology , philosophy , epistemology , horse , engineering , biology
We evaluate the effect of short sale constraint removal on a stock market. The intuition is derived from simple geometry. We show that the price curve as a function of the uncertain future payoff changes when investors are able to act on the belief that the price of the share is relatively high. In a very simple model we show that volatility can either increase or decrease, depending on the variability of news about final payoffs. As an empirical illustration, we consider data from the Israeli stock market. The data show that volatility increased following the initiation of index options, consistent with the fact that short sales were prohibited in Israel when index options were introduced.