When R2 meets the short-sales constraints

- We find that R2 increases after the lift of the short-sales constraints.
- We document that the change of R2 is from the decrease in idiosyncratic volatility.
- The result contradicts the mainstream view that high R2 means low price efficiency.
- The result supports the behavioral view that more noise trading will decrease R2.

We examine the short-selling in the Hong Kong stock market and find that, after the lift of short-sales constraint, the R2 increases, contradicting the traditional wisdom that R2 is a proxy of price inefficiency. Moreover, the change of R2 is from the decrease in idiosyncratic volatility.