The Effect of the Ban on Short Selling on Market Efficiency and Volatility

Abstract

In this paper we examine the effects of the short selling ban on trading of financial stocks imposed by Australian regulators in the wake of the global financial crisis. Unlike other developed markets where regulators imposed short-selling restrictions mostly for brief periods of time at the height of the financial crisis the ban on short selling of financial stocks on the Australian Stock Exchange lasted eight months and covered both the tumultuous end of 2008 and the calmer period up to May 2009. Our control group consists of matched Canadian financial institutions which were unaffected by the short selling ban. We examine the impact of the imposed short selling constraints on measures of market quality and stock prices with univariate and multivariate fixed effects panel regressions. As forecast by previous theoretical work we find that stocks subject to the short selling ban suffered a comparatively severe degradation in market quality. Controlling for the adverse effects of the financial crisis on financial markets we show that contrary to popular belief imposing constraints on short-selling reduced trading activity, increased bid and ask spreads and increased intraday volatility, while there appears to be no evidence for lasting price support from the restrictions.