Short selling activity, price efficiency and fundamental value of IPO stocks

In this study, we take advantage of the unique features of the Taiwan stock market, where short selling is forbidden within the first six months following an IPO. We examine the effects of short selling on IPO price efficiency and the relation between short selling activities and the fundamental value of IPO stocks. We find that price efficiency is improved with increased short selling after the lifting of short sale constraints on IPO stocks. We also show that short sellers tend to target IPO stocks with low fundamental ratios, but simultaneously avoid stocks with high transaction costs. In addition, we provide empirical evidence that short sellers focus more on temporary price fluctuations rather than temporary fluctuations in fundamentals.

► We study the impact of lifting short sale constraints in a real stock exchange.
► Price efficiency is improved with increased short selling.
► Short sellers target IPO stocks with low fundamental ratios.
► Short sellers avoid stocks with high transaction costs.
► Short sellers focus more on temporary changes in stock price.