Costly Long‐Short Strategies Under Short‐Sale Constraints: Chinese Evidence

• DOI: http://doi.org/10.1111/irfi.12160
• Published date: 01 December 2018
• Date: 01 December 2018

Costly Long-Short Strategies Under

Short-Sale Constraints: Chinese

Evidence

TIMOTHY (JUN)LU

†

,JINJUAN REN

‡

AND YAN ZHAO

§

†

Peking University—HSBC Business School, Shenzhen, China

‡

Faculty of Business Administration, University of Macau, Macau, China and

§

Lion Fund Management, HuaNan Group, GuangZhou, China

ABSTRACT

Long-short portfolios based on market anomalies are subject to ubiquitous

short-sale constraints. Few studies directly quantify the impact of shorting

on long-short strategies, largely due to the complexity of the shorting prac-

tice. We examine the Chinese market, in which the scope of the short-sale

constraint and the shorting cost are clearly specified. Among size, value, and

momentum strategies, we find that only size earns significant profits before

short-sale constraints are considered. Imposing the scope of short-sale con-

straint by selling only shortable stocks does not materially change the profits.

Deducting shorting costs, however, essentially wipes off all the profits of

long-short portfolios.

JEL Codes: G11; G12; G15

Accepted: 8 September 2017

I. INTRODUCTION

Long-short portfolios ranked by size, book-to-market ratio (Fama and French

1992), and momentum (Jegadeesh and Titman 1993) earn pronounced abnor-

mal returns in the U.S. market.

1

The persistence of these anomalies is largely

attributable to limits to arbitrage (Schwert 2003), which refrain traders from

arbitraging mispricing away (Barberis and Thaler 2003). The short-sale con-

straint, as an important perspective of limits to arbitrage, may contribute to

abnormal returns of long-short portfolios. However, shorting-related frictions

and implementation costs might render these long-short strategies

unprofitable.

Few studies directly quantify the influence of the short-sale constraint on

long-short strategies, largely due to the complexity of stock- and investor-

1 In the Chinese market, the size anomaly seems robust (Chen et al. 2015), whereas the evi-

dence on value (Wang 2004; Chen et al. 2015) and momentum anomalies (Kang et al. 2002;

Pan et al. 2013) is rather sensitive to the sample period.

© 2017 International Review of Finance Ltd. 2017

International Review of Finance, 18:4, 2018: pp. 743–751

DOI: 10.1111/irfi.12160