The Effect Of Buying Short Selling Mechanism On Stock Market

Recently, margin trading has been developing fast in China. So researching into the effect of margin trading on the market becomes meaningful. Comparing to developed countries, the stock market in China is not mature with incomplete information disclosure and inside trading. Therefore, research under the condition of information asymmetry is more practical. Existed researches agree with constraint on short-selling overvalue stocks while constraint on margin-buying undervalue stocks. However large divergence occurs in the effects on market volatility and liquidity. Based on the classic model of Grossman and Stiglitz (1980), this paper makes untradeable asset position as noise and setting margin requirements proving that:1) As for pricing, how margin requirements affect pricing depends on which one of the constraints is more restricting. More strict constraints on short-selling lead to overvaluation and more strict constraints on margin-buying lead to undervaluation.2) As for volatility, margin constraint decreases market volatility when the proportion of informed investors is low and increases market volatility when that proportion is large. When the number of the informed and the number of uniformed are around the same, whether margin requirement increases or decreases volatility depends on other market parameters.3) As for liquidity, when the informed is constrained on margin-buying, liquidity is improved by margin constraint if the constraint is not strict and is worsened if the constraint is strict. When the informed is constrained on short-selling, liquidity is worsened by margin constraint. When the uninformed is constrained on margin-buying, liquidity is improved by margin constraint. When the uninformed is constrained on short-selling, liquidity is worsened by margin constraint.Due to the equilibrium of the expected utility of the two categories of investors, the model can endogenously generate the proportion of informed investors. This proportion increases as the information quality worsens, accuracy rational expectation lowers, cost of information rises, and absolute risk aversion coefficient increases.As for China, opening margin trading alleviates the pricing distortion caused by margin requirement. Forbidding margin trading undervalues the expected asset price comparing to the situation without any margin requirement. While opening margin trading reduces the undervaluation. Forbidding margin trading decreases market volatility. While opening margin trading reduces the magnitude of the decrease. Forbidding margin trading might worsens or improves market liquidity. While opening margin trading improves market liquidity. In general, opening margin requirement improves pricing efficiency and liquidity though increases volatility slightly. Opening margin requirement in China is doing more than harm.