Short Sale Ban Research Articles

Exchange Traded Funds and the 2008 Short-Sale Ban

This paper examines the effects of the 2008 short-sale ban on exchange traded funds (ETFs). Short sales of banned stocks decreased significantly during the ban period. However, we demonstrate that a portion of that decrease was reabsorbed by financial-sector ETFs and the biggest and most liquid ETF - the S&P 500 Spider. We argue that short selling equity ETFs was a viable method of circumnavigating the ban. Additionally, we offer evidence that the supply of ETF shares available for lending was able to be increased rapidly to meet the demand through ETFs' unique creation mechanism (“create-to-lend”).

Predatory Short Selling*

Financial institutions may be vulnerable to predatory short selling. When the stock of a financial institution is shorted aggressively, leverage constraints imposed by short-term creditors can force the institution to liquidate long-term investments at fire sale prices. For financial institutions that are sufficiently close to their leverage constraints, predatory short selling equilibria co-exist with no-liquidation equilibria (the vulnerability region), or may even be the unique equilibrium outcome (the doomed region). Increased coordination among short sellers expands the doomed region, where liquidation is the unique equilibrium. Our model provides a potential justification for temporary restrictions of short selling for vulnerable institutions and can be used to assess recent empirical evidence on short-sale bans.

The cross market effects of short sale restrictions

This paper considers the impact of the 2008 short selling bans on the cross-market dynamics of stock indices across a wide range of countries. We measure the transmission of shocks between markets using a modified version of the spillover index of Diebold and Yilmaz (2009). The results show that the transmission of shocks between countries which did impose short sale bans was reduced and transmissions from countries with bans to countries without bans were also generally lower. In contrast, short sale bans did not provide protection from shocks emanating from countries which did not impose bans, as shocks from non-banning markets tended to have an increased impact on other markets during periods where bans were in place. Overall, the evidence supports the redirection of volatility in the system affecting the relationships between the groups of markets with bans and those without.

Informed Short Sellers and Stock Price Reactions to Earnings Announcements: Evidence from China

Using the special event of short selling ban removal in the Chinese stock market in March 2010, I study the relationship between short selling activities and future stock returns and the effect of short sale constraints on stock price reactions to earnings announcements. I find strong evidence supporting the Diamond and Verrecchia (1987) hypothesis that an unexpected increase in short interest predicts negative future stock returns. The long-short portfolio that buys stocks with a decline or no change in short interest and shorts stocks with an increase in short interest is able to generate a significant positive return in the following week. The positive return is strongest during the first two days, is most significant in three industries: properties, conglomerates, and industrials, is highest for big firms, growth stocks, and stocks with high short interest. Moreover, I also confirm the Diamond and Verrecchia (1987) prediction that reducing short sale constraints leads to smaller price adjustments on the private information announcement day as the stock price reaction to earnings surprises on earnings announcement day is found to be 70% lower after the short sale ban is removed. However, I don’t find evidence supporting their prediction that the reduction in price reaction is larger when negative news is released due to data limitations.

Predatory Short Selling

Financial institutions may be vulnerable to predatory short selling. When the stock of a financial institution is shorted aggressively, leverage constraints imposed by short-term creditors can force the institution to liquidate long-term investments at fire sale prices. For financial institutions that are sufficiently close to their leverage constraints, predatory short selling equilibria co-exist with no-liquidation equilibria (the vulnerability region), or may even be the unique equilibrium outcome (the doomed region). Increased coordination among short sellers expands the doomed region, where liquidation is the unique equilibrium. Our model provides a potential justification for temporary restrictions of short selling for vulnerable institutions and can be used to assess recent empirical evidence on short-sale bans.

High Frequency Trading and the 2008 Short Sale Ban

High Frequency Trading and the 2008 Short Sale Ban

The 2011 European Short Sale Ban on Financial Stocks: Cure or Curse?

This paper examines whether the 2011 European short sale ban on financial stocks proved to be successful or had a negative impact on financial markets. We explicitly take an options market perspective and focus on market participants’ changes in beliefs and expectations. During the ban, short positions in banned stocks decreased, whereas they increased for non-banned stocks. Our results indicate that the ban increased implied jump risk levels, thereby negatively impacting the banned financial stocks. However, we also observe that after the announcement of the ban, financial contagion risk actually dropped for banned stocks. Instead of a substitution effect between regular short selling and synthetic shorting through single stock puts, we observe a migration out of single stock puts into the EuroStoxx 50 index options market. We conclude that this type of migration diversified selling pressure initially concentrated in financial stocks across a larger share of the stock market, thereby reducing systemic risks and enhancing overall financial stability.

The Intended and Collateral Effects of Short-Sale Bans as a Regulatory Tool

Short-sale bans have been frequently utilized globally as a regulatory tool during periods of financial crisis. This paper is a review of the observed intended and unintended effects. We see that short-sale bans have pervasive effects spanning many financial markets that include options, convertible bonds, CDS, and ETFs. Such implications should be of interest to regulators and policymakers when contemplating future bans.

Short-sale constraints and efficiency of the spot–futures dynamics

This paper studies the spot and futures cross-market efficiency implications of the regulatory short-selling constraints imposed during the 2008–2009 financial crisis. We find that the equilibrium position for the basis during the ban period is below that normally seen, with the spot price higher relative to the futures price. This suggests that holding the spot was more valuable than holding the futures during the ban period. Further, we find that the speed of adjustment has slowed down and in some cases become statistically insignificant, suggesting that arbitrage is less effective during the ban period. The results presented here have implications for regulators and traders regarding the efficiency of these markets during a short-sale ban.

Do option markets undo restrictions on short sales? Evidence from the 2008 short-sale ban

The effectiveness of any sanction depends on the costs of avoiding its restrictions. We examine whether bearish option strategies were substitutes for short sales during the September 2008 short-sale ban. We find a significant diminution in option volumes and a significant increase in option bid-ask spreads for banned stock relative to unbanned stock during the ban period. Apparent violations of the put-call parity bound became significantly more frequent for banned stocks during the ban period. We conclude that the ban acted as an effective restriction on trading in options.

Derivatives traders’ reaction to mispricing in the underlying equity

This article examines trading behavior in the options market conditioned on mispricing in the underlying stock. We investigate the price equilibrium between the observed equity asset and the options-implied synthetic share as well as the relative divergence between the two prices. We find a consistently positive relation between the level of stock mispricing and violations of the upper-boundary condition using derivatives, along with an increase in price divergence. To control for the effect of shorting limitations on mispricing, we further examine prices during the short-sale ban in 2008. The results hold and in many instances are more significant during the ban period. Given the persistent disequilibria between the synthetic and observed stock prices, we argue the results are evidence of informed trading in the derivatives market.

Dual-Listed Shares and Trading

We study companies with dual-listed shares in China (mainland) and Hong Kong. When China has a short-sale ban, Chinese stock prices are 1.8 as high as Hong Kong prices (on average). Stock pairs with higher fundamental volatilities or more volatile order ows have higher price disparities (on average). The average stock pair’s return dierence is volatile and has a standard deviation of 8.8% per week. This paper shows that order ows can aect both a company’s fundamental price and/or its transitory prices. In Hong Kong, transitory variance accounts for 39% of a stock’s total variance. These results are surprising because the average market capitalization is over USD 8 billion for the Hong Kong-listed shares and the turnover is over 2.5 per annum. We exploit a quasi-natural experiment in which the short-sale ban is lifted for some Chinese stocks but not others. After the ban is lifted, the aected shares trade at parity. We estimate that lifting the short-sale ban in China (mainland) reduces weekly transitory volatility in Hong Kong by 49 bp per week because it enables a hedging mechanism.

Do short selling restrictions destabilize stock markets? Lessons from Taiwan

Short sellers have been routinely blamed for triggering, or exacerbating, stock market declines. The experience of Taiwan provides an interesting case study of the impact of short selling bans on stock returns volatility in a time series framework due to the length of time the short selling ban was in place there. Estimating several variants of an asymmetric GARCH model and a Markov switching GARCH model we find robust evidence that short selling restrictions raise stock returns volatility. The only qualifier is that the impact of short sale bans is a feature of the expansionary phase of business cycles. During recessions this effect dissipates.

Short-Sale Constraints and Efficiency of the Spot-Futures Dynamics

This paper studies the spot and futures cross-market efficiency implications of the regulatory short-selling constraints imposed during the 2008-2009 financial crisis. We find the equilibrium position for the basis during the ban is below that normally seen, with the spot price higher relative to the futures price. This suggests that holding the spot was more valuable than holding the futures during the ban period. Further, we find the speed of adjustment has slowed down and in some cases become statistically insignificant, suggesting arbitrage is less effective during the ban period. The results presented here have implications for regulators and traders regarding the efficiency of these markets during a short-sale ban.

Sovereign CDS Spreads, Volatility, and Liquidity: Evidence from 2010 German Short Sale Ban

AbstractThe paper examines global impact of 2010 German short sale ban on sovereign credit default swap (CDS) spreads, volatility, and liquidity across 54 countries. We find that CDS spreads continue rising after the ban in the debt crisis region, which suggests that the short selling ban is incapable of suppressing soaring borrowing costs in these countries. However, we find that the ban helps stabilize the CDS market by reducing CDS volatility. The reduction in CDS volatility is greater in the eurozone than that in the non‐eurozone. Furthermore, we find that the CDS market liquidity has been impaired during the ban for the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) countries. In contrast, there are no dramatic changes in the market liquidity for non‐PIIGS eurozone and non‐eurozone samples. The findings suggest that the short sale ban is ineffective to reduce sovereign borrowing costs in the debt crisis region if the underlying economy has not been significantly improved.

Short-Selling Status and Asset-Pricing Models

Using the uniqueness of Hong Kong regulations on short selling, I find that the CAPM, the Fama-French Three-Factor and the Four-Factor model fare significantly better in capturing the cross-section of expected returns on the stocks which are shortable than the stocks which are not. The results imply that applying the three asset-pricing models to the stocks/markets where short sales are restricted would produce biased estimates. All the three models for portfolios without short-sale constraints have significantly higher R2 and adjusted R2 than for portfolios that are banned to be sold short. This suggests that the three models are much less capable of capturing the average stock returns in the environment of short-sale ban or constraints than in the environment of no such restrictions. This result is generally supported by other measures I use to evaluate the performance of the models, such as the absolute value of alphas and the GRS statistics (except for the four-factor model), and is robust to higher frequency data (weekly data). The implication is that practitioners and academics alike need to be cautious about applying the extant asset-pricing models to circumstances where short-sale restrictions are present in various forms.

The Impact of the 2008 Short Sale Ban on Stock Returns

The ban on short selling exacerbated the asymmetry of the return distribution of the stocks subject to it, and did nothing to limit the extreme variations in their returns. Their volatility increased substantially more than that of the market as a whole. At the same time, and partly as a result of the ban, the betas of these stocks (which reflect their systematic risk) remained unchanged or decreased. Therefore, the ban introduced noise in the stock price fluctuations (idiosyncratic risk increased) and made these prices deviate even farther from their fundamental values. The increase in realized volatility in turn translated into an increase in implied volatilities and thus an increase in option prices.

Regulatory Uncertainty and Market Liquidity: The 2008 Short Sale Ban's Impact on Equity Option Markets

ABSTRACTWe examine how the September 2008 short sale restrictions and the accompanying confusion and regulatory uncertainty impacted equity option markets. We find that the short sale ban is associated with dramatically increased bid‐ask spreads for options on banned stocks. In addition, synthetic share prices for banned stocks become significantly lower than actual share prices during the ban. We find similar results for synthetic share prices of hard‐to‐borrow stocks, suggesting that the dislocation in actual and synthetic share prices is attributable to the increased hedging costs for options on banned stocks during the short sale ban.

Traversing the Short-Sale-Ban and the No-Ban Regime: A New Tale of the Old Overvaluation Story

Recent studies add to the evidence against Miller’s (1977) overvaluation theory, further dwarfing the already sparse evidence for the theory. In this paper, we identify several issues untouched so far. Addressing these issues simultaneously, we conceive a novel empirical identification strategy which (1) looks at short-sale bans rather than short-sale constraints; (2) treats a short-sale ban (or no ban) as a regime rather than as an event; (3) probes the same stock that traverses the ban and no-ban regimes rather than different stocks concurrently under different regimes or the same regime; and (4) allows for possible endogeneity in regulators’ decision to change the short-selling regime for a stock. Employing data from the Hong Kong market, we find robust and strong evidence for Miller’s theory. Stocks earn significantly higher abnormal returns in the ban regime than in the no-ban regime. The ban regime and wider dispersion of investor opinions reinforce each other in further increasing current, while further reducing subsequent, returns to individual stocks. The tick rule acts as a short-sale constraint to impair the negative price effects of the no-ban regime.

Put-Call Parity Violations and Return Predictability: Evidence from the 2008 Short Sale Ban

We show that the 2008 short-sale ban significantly enhanced the return predictability of put-call parity violations and attribute the significant increase in violations to stock over-valuation. The top quantile put-call parity violation portfolio under-performs the lowest quantile portfolio by a risk-adjusted daily return of 2.8% during the ban period. Panel regression analysis documents that a significant increase in return predictability during the ban is more pronounced for stocks with liquid options, further corroborating our results. Our findings are robust to a number of controls aimed at alleviating concerns that other concurrent policy changes and events might be driving our results.