The influence of short sale constraints on the relationship between biased individual behavior and market prices

• Applicant: Professor Dr. Alexander Klos
• Subject Area: Accounting and Finance
• Term: from 2013 to 2015
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 244313114

During the recent financial crisis a number of countries restricted short-selling. Most economists agree that the goal of decreasing speculation has not been accomplished and predominantly disapprove of short-selling constraints in general.This project asks whether short-selling constraints lead behavioral biases to become more influential on the market level. This research question is of particular interest from a scientific perspective. The project uses experimental and empirical approaches.We will utilize the design of Gneezy et al. (2003) in the experimental part of the project, where a lottery is traded in an experimental asset market. The framing of the lottery significantly influences the market price; Gneezy et al. interpret this as evidence that indicates that behavioral phenomena influence market prices. If the introduction of short-selling eliminates the mispricing, we can conclude that short-selling constraints increase the influence of behavioral biases on markets.In the empirical part of this study, we will study the return of momentum strategies in different countries and time periods with and without short-selling constraints. We will study countries that were constrained for a long period as well as the natural experiment of the short-selling bans that were enacted during the financial crisis. Many researchers believe that behavioral approaches can explain the profitability and persistence of the momentum effect. Hence, a positive correlation between short-selling constraints and momentum returns could be viewed as evidence of a stronger influence of behavioral biases on market prices.

• DFG Programme: Research Grants