Short Selling Bans and Market Liquidity around the World: Evidence from the 2007-09 Crisis

Abstract

Most stock exchange regulators around the world have reacted to the financial crisis of 2007-2009 by imposing bans or regulatory constraints on short-selling by market participants. We use the large amount of evidence generated by the introduction and lifting of these bans to investigate the effects of short-selling bans on liquidity and price discovery. The enactment and lifting of bans at different dates in different countries, in some countries for financial stocks only, and often with different degrees of stringency, enables us to use panel data techniques to investigate their effects. We also investigate the cross-sectional effect of bans on liquidity of stocks with different market capitalization and different volatility. Finally, we analyze the effect of bans on other measures of market quality, such as price discovery and the skewness of stock returns. Short-selling is an integral part of the trading strategies of institutional investors, in particular hedge funds. Our research has the potential to show to regulators that banning short selling has detrimental effects on market quality and, as a result, it is not an appropriate policy action.