Chapter 24 - Short Selling and the Problem of Market Maturity in Latin America

Abstract

This chapter presents practices and regulatory policies regarding short selling in Latin America. Unlike developed economies where portfolio optimization techniques work well to assess the appropriateness of short selling strategies in stock markets, Latin American economies have particular structural features that complicate the regulatory environment of capital markets by affecting the effective execution of short sales. Latin American financial markets are structurally different in terms of reduced liquidity, limited price formation, unavailability of information, and small economic size, making it difficult to assess the appropriateness of certain types of securities regulation and short selling norms. Moreover, the existence of factors affecting country risk perception from the perspective of international investors trading emerging countries stocks in developed economies through American and Global depository receipts complicates the work of regulators. In this context, it is worth wondering if portfolio theory and optimization techniques are relevant for evaluating the integration of short positions in asset allocation strategies in Latin America. Due to the macroeconomic imbalances to which countries have been exposed to in Latin America, the main factors that lead speculators to short sell are related to sovereign risk. Even though short sales are banned or not feasible in a big proportion of Latin American stock markets, it would be reasonable to expect that when such markets become better developed, regulators will need to regulate short selling as agents find mechanisms and utilize more sophisticated tools to short sell.