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Professor Baohua Xin
Associate Professor, PhD Program Coordinator (Accounting)
Rotman School of Management
University of Toronto

We examine the effects of margin trading and short selling on the trading behavior of small retail investors. Leveraging a staggered introduction of margin trading and short selling for a selected group of securities (pilot stocks) in an economy with high retail investor participation and a relatively weak information environment, we document that pilot stocks experience a significant decline in small retail trading. This decline is more pronounced among pilot stocks with higher levels of information asymmetry. Further analysis indicates that the change in participation of small retail investors, prompted by the introduction of margin trading and short selling, contributes to a deterioration in the market quality of pilot stocks. Our findings provide empirical support for classical adverse selection theories of informed trading (e.g., Glosten and Milgrom, 1985, Easley and O’hara, 2004).