This paper examines how individual investors’ short sale transactions affect the stock market, using a unique regulatory change in Korea that allowed individual investors to sell short some―but not all―domestic stocks. We find no evidence that these transactions destabilize the market. Specifically, our differences-in-differences estimates indicate that stocks show little change in their return volatility or skewness after they become shortable. Rather, following the regulatory change, those stocks are traded within a narrower bid-ask spread and deviate less from the random-walk process, suggesting that they are priced more efficiently. Overall, our results cast doubt on the popular stereotyping of individual investors as noise traders. The results instead indicate that individual investors are capable of bringing in private information to the market.
Keywords: Short sale; Individual investors; Korean stock market; Destabilizing
JEL classification: G10, G14, G20
