AbstractSeveral models are developed to examine the portfolio effect of short selling. Three things are demonstrated in this study. First, that for many assets, short selling is a useful strategy for reducing risk when constructing mean‐variance efficient portfolios. Second, Regulation T can be used in combination with short selling to further improve expected portfolio performance. Third, the performance of the suggested models is superior to previously suggested allocation models. Ex ante and ex post tests are conducted to arrive at the above conclusion