By Jessica Wilson


Ivalina Kalcheva.  Photo by Thomas Veneklasen.

Ivalina Kalcheva.
Photo by Thomas Veneklasen.

Is the stock market an example of an efficient market?

“The efficient market hypothesis says that prices of securities fully reflect all available information about securities,” Ivalina Kalcheva, assistant professor of finance at the Eller College. “In the big picture, these prices feed back into the economy to help allocate risk and capital.”

One effect of an efficient market, she said, is that “You can’t beat the market, which is the base for development of passive investment vehicles known as index funds—a type of mutual fund that tracks the components of a market index, such as the Standard & Poor’s 500 Index.” If the hypothesis is true, then the prices of stocks change only because of the day’s news, not because of yesterday’s forecasts.

Researchers have long noticed an anomaly in stock trading known as the weekend effect. “This is the phenomenon in financial markets in which stock returns on Mondays are often significantly lower than those of the immediately preceding Friday,” explained Kalcheva. The weekend effect is a challenge to the efficient market hypothesis, making it a compelling topic of study for researchers. One explanation for the weekend effect is the practice of short-selling.

Short-selling occurs when an investor sells a stock and then buys it. Kalcheva explained it as follows: “Normally, an investor would first buy a stock and later sell it. With a short sale, the order is reversed. First, you sell and then buy the shares—you sell shares not owned but borrowed through a broker and later purchased to replace the loan. In both cases, you begin and end with no shares. A short sale allows investors to profit from a decline in a security’s price.”

For the paper, “Short Sales and the Weekend Effect – Evidence from a Natural Experiment,” Kalcheva and her co-authors took advantage of information from the Hong Kong Stock Exchange to see if short-selling could be a cause of the weekend effect. They used data from the Hong Kong Stock Exchange because short-selling was not allowed there before 1994, and allowed for only a few stocks after 1994.

Kalcheva’s findings demonstrate a strong weekend effect during the pre-1994 period, when short-selling didn’t occur, and during the post-1994 period for both stocks that were allowed to be sold short and those that were not. “Moreover, the difference in the weekend effects between the two groups was economically and statistically indistinguishable,” she said. “It has been contended that short-sellers may exert temporary price pressures and contribute to the renowned weekend effect, but we find that this is not the case.”

The existence of the weekend effect is still significant, especially as it relates to proving or disproving the efficient market hypothesis, however, “Researchers have to look for other explanations than short-selling,” Kalcheva concluded.

Top image of business screen stock exchange data graph background courtesy Shutterstock.