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1 November 2013 CFA Institute Journal Review

Short-Selling Bans around the World: Evidence from the 2007–09 Crisis (Digest Summary)

  1. Nitin Joshi

Bans on short selling during the 2007–09 crisis resulted in less liquidity, slow price discovery, and a failure to support stock prices, except possibly in US financial markets.

What’s Inside?

Most regulators around the world reacted to the 2007–09 crisis by imposing bans on short selling. The authors analyze the impact of bans on short selling using panel and matching techniques. Panel data, also called longitudinal data or cross-sectional time-series data, are data in which the same entities (panels), such as people, firms, or countries, are observed at multiple time points. Matching analysis has become a popular method for estimating causal effects and reducing model dependence. The authors find that bans on short selling reduced market liquidity, especially for stocks with small capitalizations and no listed options; hindered price discovery, especially in bear markets; and failed to support stock prices, except for possibly in US financial markets, which was the primary reason they were enacted.

How Is This Research Useful to Practitioners?

Market liquidity, price discovery, and the level of stock prices are key factors to consider for all capital market participants. The authors study the effects of the ban on short selling using panel data and event study techniques.

Their results indicate that after controlling for other variables, the short-selling bans imposed during the crisis were associated with a statistically and economically significant liquidity disruption, revealed by an increase in bid–ask spreads and the Amihud illiquidity indicator. They also find that the short selling bans slowed price discovery, especially when accompanied by negative news, and that the bans were not associated with better stock price performance except in the US market.

The authors conclude that imposing bans or regulatory constraints on short selling was detrimental for market liquidity, especially for stocks with small market capitalizations, high volatility, and no listed options. In addition, with the slowdown in price discovery, the effort was, at best, neutral in its effects on stock prices.

How Did the Authors Conduct This Research?

The sample consists of daily data for 16,491 stocks in 30 countries (most European markets and developed non-European markets) from 1 January 2008 to 23 June 2009. It includes daily bid and ask prices, volumes, short-selling ban characteristics, inception dates, and dates the bans were lifted.

For each country, the authors first determine whether a short-selling ban was enacted during the study period. If there was a ban, they then determine when it went into effect, which stocks it applied to, which restrictions it imposed, and when it was lifted. They assess the impact of the short-selling bans on liquidity, controlling for the effect of stock-specific characteristics and return volatility on bid–ask spreads.

To measure short-sale restrictions, the authors create three dichotomous variables that relate to the severity of the restriction: naked ban (no naked short sales), covered ban (no covered short sales), and disclosure (requirements for disclosure). They also use an event study methodology to test the effect of short-selling bans over a window of 50 days before and 50 days after the inception date of the bans for countries that imposed partial bans.

Abstractor’s Viewpoint

Restrictions on short sales across the world during the 2007–09 financial crisis had unintended effects in terms of reduced market liquidity when investors were desperately seeking liquid markets, slow price discovery, and failure to support security prices. The authors show that the costs of the short-sale ban outweighed the benefits. It is to be hoped that regulators will make use of the wealth of data generated about the effects of short-selling bans before security markets face the next crisis.

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