Price Inflation and Wealth Transfer During the 2008 SEC Short-Sale Ban

Abstract

Using a factor-analytic model that extracts common valuation information from the prices of stocks that were not banned, we estimate that the ban on short-selling financial stocks imposed by the SEC in September 2008 led to substantial price inflation in the banned stocks. For stocks experiencing negative performance prior to the ban, the inflation reversed approximately two weeks following the ban. Although stocks with positive pre-ban performance where estimated to have realized a similar magnitude of inflation during the ban, we find little evidence of a postban reversal for this subset of stocks. The reversal evidence suggests the effects of the short-sale ban may have been limited to stocks with negative price pressure prior to the ban. Other factors such as the pending TARP legislation may also have affected prices, though our results suggest that it was not a significant factor. If prices were inflated, buyers paid more than they otherwise would have paid for the banned stocks during the period of the ban. We provide an estimate of $2.3 to $4.9 billion for the resulting wealth transfer from buyers to sellers, depending on how post-ban reversal evidence is interpreted. Such transfers should interest policymakers concerned with maintaining fair markets.