Banning Short Sales and Market Quality: The U.K.'s Experience

Ian W Marsh,Richard G Payne

doi:10.2139/ssrn.1645847

Abstract

We study the effects that the ban on short sales of shares in financial firms introduced in late 2008 and removed early 2009 had on the microstructure and the quality of UK equity markets. We show that the ban did nothing to affect order flows: financial stocks were being more aggressively sold off than their peers pre-ban and this situation persisted through the ban period. Trading volume in financials was massively reduced, however. The ban also decimated order book liquidity for financials. The deterioration was symmetric, affecting the limit buy and limit sell side of the order book equally. Finally we show that, through the period of the ban, markets for financial stocks were substantially less efficient and that the role of the trading process aiding in price discovery was greatly reduced. The effects identified above were largely reversed once the ban was lifted. We thus argue that the ban had detrimental effects on the quality of UK equity markets and that, far from being stabilising, the ban exacerbated problems of volatility in the prices of and uncertainty in the values of UK financial stocks.

Highlights

Short selling is the practice of selling a security that an agent does not own
In this paper we have compared examined several the microstructurale indicators of conditions prevailing inof U.K. stock markets between June 2008 and February 2009. This period spans the introduction and subsequent removal of new provisions to the Code of Market Conduct issued by the Financial Services Authority that banned the creation or increase of net short positions in publicly quoted U.K. financial companies
Was there any clear difference between the microstructural behaviour of financial stocks and set of control group stocks that might have motivated the Financial Services Authority (FSA)’s move to ban short-selling? Since figures in the FSA spoke of “incoherence” in stock markets and stated that “disorderly” conditions prevailed in the period prior to the ban’s introduction we might have expected to find evidence of abnormal conditions in the market for financial company stocks in the period before 18th September 2008

Summary

Introduction

Short selling is the practice of selling a security that an agent does not own. Speculators short sell a security with the intention of buying it back at a later date at a lower price, so as to profit from a price decline.1 While frequently attracting ire from executives of companies subjected to short selling pressuresthe practice, some form of short selling is usually permitted in most major stock markets since short sellers may add liquidity to the market and can contribute to price discovery. Trading volume for financials fell by 40% relative to the control group during the period the ban on short selling was effective, more for larger financial stocks.

Results

Conclusion