Short-sale constraints, information acquisition, and asset prices

This paper develops a model of information acquisition and portfolio choice under short-sale constraints. We show that short-sale constraints reduce information acquisition and both the constraints on short-selling and the reduced information acquisition affect investment decisions. The effects of short-sale constraints on investment decisions and asset prices are driven largely by the effects on information acquisition, and such effects vary depending on the return and risk characteristics of the risky assets. The model offers explanations for the level and distribution of short interest, the relation between short-selling and stock returns, and provides new predictions on the asset pricing implications of short-sale constraints. JEL Codes: G11, G14