Chapter 36 - Short Sale Constraints in the Equity Market and the Term Structure of Interest Rates

Abstract

This chapter focuses on the effects of the ban on short selling in US equity markets on the term-structure of interest rates. As stocks and bonds are part of diversified portfolios of any average institutional investor, constraining the positions on the stocks clearly have an impact on the demand for bonds and thus on their prices. The volatility of the default spread and of inflation-related spreads clearly increased by a factor of more than five when the ban was instated. The short ban of summer 2008 had a negative impact on skewness of the innovations, whereas the ban of summer 2008 had a positive impact. The crisis dummy was statistically significant in the vast majority of cases and with a positive sign. The two bans had a positive and significant impact on nominal term spreads, and both short bans had a positive impact on the kurtosis of these spreads. Thus banning short sells generated extreme market movements in markets other than equity markets.