Short-selling Bans Research Articles

The Causal Effects of Short-Selling Bans: Evidence from Eligibility Thresholds

We identify the causal effects of short-selling bans on stock prices using regression discontinuity (RD). We exploit three threshold-based rules that determine a stock’s short-selling eligibility on the Hong Kong Stock Exchange. Short-selling bans have a large effect on short-selling volume at all thresholds. Despite this, bans do not affect stock prices. Stock returns, volatility, and crash risk are not different for banned versus unrestricted stocks when appropriate counterfactual stocks are used to measure a ban’s effects. Our findings suggest that short-selling bans are not as costly as previously argued, but are ineffective at reducing volatility or buttressing prices. Received September 13, 2017; editorial decision April 29, 2018 by Editor Jeffrey Pontiff.

Short-Selling Bans and the Global Financial Crisis: Are They Interconnected?

Abstract This paper begins with the observation that short-selling bans spread globally in 2008. We find some evidence that the bans were unsuccessful at least insofar as they did not take into account the global component a short-selling ban which reduced equity returns in about a third of the 17 countries sampled, most notably in some of the major advanced economies. In the individual countries we examine, the bans had relatively little impact. Our results are suggestive as evidence that the bans stemmed further deterioration in stock prices that policy makers sought to avoid, at least in a few economies. JEL classifications: G10, G12 Keywords: Short-selling bans, spillovers, stock markets, dynamic conditional correlations

Short-Selling Bans and Bank Stability

In both the subprime crisis and the euro-area crisis, regulators imposed bans on short sales, aimed mainly at preventing stock price turbulence from destabilizing financial institutions. Contrary to the regulators’ intentions, financial institutions whose stocks were banned experienced greater increases in the probability of default and volatility than unbanned ones, and these increases were larger for more vulnerable financial institutions. To take into account the endogeneity of short sales bans, we match banned financial institutions with unbanned ones of similar size and riskiness, and instrument the 2011 ban decisions with regulators’ propensity to impose a ban in the 2008 crisis.

A Study on the Impact of the Short Selling Ban on FIBS

In this paper we investigate how the short selling ban affected stock markets in France, Italy, Belgium and Spain and whether the required response was really achieved and reflected in the market. Although some argue that the short selling ban was needed for the market to get back on its feet, others argue that short selling is a tool that improves market efficiency and banning such trading strategy might lead to detrimental effects on the market. Therefore, the purpose of this study was to show whether the short selling ban had a positive or negative effect, both in the short-term and long-term, on the financial markets. Moreover, to determine whether short selling is an effective tool and whether it really drives the stock prices down when the financial markets are going through bad moments. Consequently, uncover whether the short selling ban has had a permanent impact on the financial markets and whether it really had an effect on the FIBS. To do this we used market data and a selection of stock returns, which included banned stocks in the FIBS financial markets and non-banned financial stocks from non-FIBS before, during and after the short-selling ban in August 2011. It was found that the short selling ban led to higher volatility in the FIBS countries and also had a spill over effect on non-FIBS countries. Furthermore, the impact of the short selling ban on volatility was only deemed to be for a short-term period, with the exception of Spain. Also, the short selling ban slowed down price discovery in Belgium, France and non-FIBS countries, whereas the short selling ban did not affect Spain and Italy. Furthermore, all countries including the non-FIBS countries illustrated a better price discovery position after the ban was lifted; therefore the short selling ban only had a short-term impact on price discovery. Moreover, there was a long-term positive effect on prices with improvement in stock market prices for all FIBS countries with a positive impact on non-FIBS countries. However, liquidity in all FIBS and non-FIBS countries suffered a short-term negative impact.

Global and Extreme Dependence Between Investor Sentiment and Stock Returns in European Markets

ABSTRACTThe authors investigate the global and extreme dependence structure between investor sentiment and stock returns in 7 European stock markets (Belgium, France, Germany, Greece, the Netherlands, Portugal, and the UK), over the period 1985–2015. Global dependence refers to the correlation of changes in sentiment and stock returns over the whole range of these 2 variables, and extreme dependence refers to the local correlation of high (i.e. asymptotic) changes in sentiment and high stock returns. Using copula models and a bootstrap procedure, 6 statistical tests are performed for this purpose. Among the results of the tests, the authors highlight those that provide evidence of contemporaneous lower extreme dependence and contemporaneous upper extreme independence between sentiment and returns. As policy implications, these results suggest that financial stability can be promoted if regulators consider the impact of their decisions on investor sentiment. Also, the results seem to support the arguments in favor of short selling ban during turmoil periods. Finally, overall, the results are relevant for both investors and regulators and reinforce the importance of considering investor sentiment to better understand the behavior of financial markets.

Equity-Market Trading Restrictions and Credit Prices: Evidence from Short-Sale Constraints Around the World

We examine how equity-market trading restrictions affect credit prices. Using short-sale constraints (SSCs) as a proxy for trading restrictions, we examine two specific sources of variation — the randomized Regulation SHO experiment and time-series variation in short-selling bans during the 2008 financial crisis. In both analyses, we find that greater SSCs are associated with significantly higher credit-default-swap (CDS) spreads. Changes in the term structure of CDS spreads suggest that this increase is attributable to a decrease in the availability of default-risk-relevant information. Further, using a default-model-prediction framework, we document that it is more difficult to accurately assess default risk when short selling is constrained, which corroborates information risk as a channel through which SSCs lead to higher credit prices.

Bid- and ask-side liquidity in the NYSE limit order book

We disentangle bid- and ask-side liquidity using 11 years of comprehensive New York Stock Exchange limit order book data to document several empirical facts improving our understanding of the determinants, commonality, and pricing of liquidity. First, the ask- but not bid-side liquidity of financial stocks deteriorates during the 2008 short-selling ban. Second, ask- (bid-)side liquidity increases (decreases) in lagged short- and long-term returns. Third, liquidity commonality increases during the financial crisis, more so on the bid- than on the ask-side. Finally, ask- but not bid-side illiquidity predicts daily returns, while both forecast monthly returns.

Short-sale constraints, information acquisition, and asset prices

During financial crises, financial market regulators often restrict short-selling to support prices and curb volatility. However, evidence suggests that short-selling bans during the turmoil in financial markets in 2007–2009 failed to achieve regulators' goals. We analyze a model of costly private information acquisition and asset pricing under short-sale constraints to examine a possible cause of this failure. We show that the constraints increase return volatility by adversely affecting the production of private information. When investors are highly risk averse or are holding highly correlated risky assets, the distortion in private information production arising from imposing short-sale constraints leads to undervaluation, implying that imposing short-selling bans during economic crises not only fails to curb volatility but also may fail to support prices.

How the Australian Ban on Short Selling During the GFC Affected Market Quality and Volatility

We examine the effects of the short selling ban, imposed by Australian regulators in the wake of the global financial crisis, on trading of financial stocks. Unlike other developed markets, where regulators imposed short-selling restrictions 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, including 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 a short selling ban. We analyze the impact of the imposed short selling constraints on measures of market quality and on stock prices using univariate and multivariate fixed effects panel regressions. As predicted by previous theoretical work, we find that stocks subject to the short selling ban suffered a severe degradation in market quality. Controlling for the adverse effects of the financial crisis on financial markets, we show that imposing constraints on short-selling reduced trading activity, increased bid and ask spreads and increased intraday volatility. Moreover, there appears to be no evidence for lasting price support from the restrictions.

Information Contents of Short Selling Restriction and Stock Lending and Borrowing Transactions

This study focuses on the distinctive incident in which Stock Lending and Borrowing (SLB) transaction and short selling grew continuously even during the wavering period of the Korea Composite Stock Price Index (KOSPI) in the Korea Exchange (KRX) market. The authors analyze the information contents of SLB and short selling on KOSPI financial stocks. The financial stocks were freed from short selling ban on November 14, 2013, after being banned for more than five years following the global financial crisis in 2008. Employing the event study methodology, the authors also analyze the differences between stock market returns before and after the short selling ban. The results of this study show that the concentrated group including high levels of SLB and short selling were characterized by the higher Abnormal Return (AR) with negative effect than the comparative group after the occurrence of short sales. The results also discover that SLB and short selling transactions provide the market with significant information contents. The information effect of SLB and short selling is consistent over time, but is stronger when the transactions are more concentrated. Finally, the results reveal that the short selling has the most considerable influence on the stock market.

Option Prices and Costly Short-Selling

We provide an analysis of option prices with costly short-selling. Short-sellers incur a shorting fee to borrow stock shares from investors who do not necessarily lend all their long positions (partial lending). We incorporate costly short-selling and options market-making into the classic Black-Scholes framework and obtain unique option bid and ask prices in closed-form. Option prices represent market-makers' expected cost of hedging, and are in terms of and preserve the well-known properties of the Black-Scholes prices. Consistently with empirical evidence, we show that bid-ask spreads of typical options and apparent put-call parity violations are increasing in the shorting fee. We also find that option bid-ask spreads are decreasing in the partial lending, and the effects of costly short-selling on option bid-ask spreads are more pronounced for relatively illiquid options with lower trading activity. We then apply our model to the recent 2008 short-selling ban period and obtain implications consistent with the documented behavior of option prices of banned stocks. Finally, our quantitative analysis reveals that the effects of costly short-selling on option prices are economically significant for expensive-to-short stocks and also sheds light on the behavior of option prices and apparent mispricings of the Palm stock in 2000.

Why Do Short Selling Bans Increase Adverse Selection?

Why Do Short Selling Bans Increase Adverse Selection?

Regulatory overkill? Short-sales ban in Korea

Purpose The authors investigate the 2008-2009 short-sales ban in Korea, one of the most comprehensive and restrictive short-selling bans worldwide. The purpose of this paper is to examine: whether the ban stopped a destabilizing effect, if there was any, of short-selling activities; whether the ban improved or deteriorated the informational efficiency or the price discovery process of the stock market; and whether the ban had any impact on market liquidity. Design/methodology/approach Multiple regression; vector autoregression analysis; and generalized autoregressive conditional heteroskedasticity analysis. Findings The authors find no evidence that short-sales have a market-destabilizing effect and thus, restricting short-selling has a market-stabilizing effect. On the contrary, the short-selling ban is associated with an increase in return volatility and a deterioration of the price discovery process, particularly for the stocks without derivatives traded on them. The authors also find evidence of a liquidity decrease for short-sale intensive stocks. However, the evidence is inconclusive as to whether the market efficiency and liquidity changes are solely the result of the short-sales ban or the compound effects of both the ban and the concurrent progress of the financial crisis. Originality/value The literature does not provide a conclusive view on the effects of short-sales or restrictions thereof on the stock market. Also, the existing research on recent worldwide shorting bans often lack empirical scope (e.g. 32 stocks for UK; three weeks for USA). In contrast, the short-sales ban in the Korean stock market, one of the most comprehensive and restrictive short-selling bans worldwide, lasted for eight months for all the listed stocks and is still in effect for financial stocks. The authors find no evidence that short-sales have a market-destabilizing effect and thus, restricting short-selling has a market-stabilizing effect.

Short Selling Ban and Its Impact to Stock Market

Most of the financial regulators around the world such as ASIC, FSMA, CSRC, AMF, FFSA, FCA, SEC reacted to the 2007-09 turmoil and 2011 Greek debt crisis by imposing short sales restrictions. These series of events held and elevated at different dates and in different nations based on various sets of stocks featuring degree of severity. This paper examined several findings of research on shorting bans and its impacts to the security market in different aspects such as stock price and its behavior during ban, price discovery and the liquidity. It is also found that during the ban, activity related to shorting dropped by 77% and smallest stocks that was related to the ban underwent severely in market quality based on spreads, intraday volatility and price impacts. Those stocks, which are listed, did not provide any price impact but during the whole banning period it was underperforming constantly. Evidences portrays that the shorting ban did not generate any simulated improve in prices.

Pricing derivatives in the presence of shadow costs of incomplete information and short sales

Financial models are based on the standard assumptions of frictionless markets, complete information, no transaction costs and no taxes and borrowing and short selling without restrictions. Merton’s (J Finance 42:483–510, 1987) develops a simple model of capital market equilibrium with incomplete information. Wu et al. (Rev Quant Finance Account 7:119–136, 1996) extend Merton’s (J Finance 42:483–510, 1987) model by proposing an incomplete information capital market equilibrium with heterogeneous expectations and short sale restrictions, GCAPM. The shadow costs include two components. The first component is the product of pure information cost due to imperfect knowledge and heterogeneous expectations. The second component represents the additional cost caused by the short-selling constraint. Short-selling bans around the world after the global financial crisis become more and more important. Nezafat and Wang (Short-sale constraints, information acquisition, and asset prices, Scheller College of Business, Georgia Institute of Technology, Atlanta, p 30308, 2013) develop a model of information acquisition and portfolio choice under short-sale constraints. Bellalah (J Futures Mark, 1999) and Bellalah and Wu (Ann Oper Res 165:123–143, 2009) include information costs the valuation of assets and derivatives. This is the first study to our knowledge devoted to the pricing of derivatives that accounts simultaneously for information costs and short sales constraints for the option market and its underlying asset market. We extend the classic models by Black and Scholes (J Polit Econ 81:637–659, 1973), Black (J Financ Econ 79(3):167–179, 1976), and Barone-Adesi and Whaley (J Finance 2(81):303–320, 1987) among others to account for shadow costs of incomplete information and short sales. We present a general method and provide the general differential equation for the pricing of derivatives within incomplete information and short selling costs.

Order Execution and Price Discovery During the 2008 Financial Crisis

We examine 46 cross-listings characterized by varying degrees of order execution from Canada, Brazil, and Mexico onto the NYSE during 2008. We develop a measure of order execution advantage (OEA) and find that OEA and price discovery migrate towards the home market during the financial crisis in the latter part of 2008, and notably more for firms subjected to the short selling ban imposed by the SEC. We show the NYSE’s percent adjustment to exchange rates and differences in price impacts are key variables that capture cross-sectional variation in the NYSE’s share in price discovery.

The Impact of the 2011 Short-Sale Ban on Financial Stability: Evidence from the Spanish Stock Market

We examine the effect of the 2011 short-selling ban on Spanish stocks on the financial sector's risk level. Before the ban, short positions were positive and significantly related to several indicators of bank default risk. Subsequently, the ban moderated the risk of banking institutions, especially those more exposed to short-seller activity, which, on average, showed higher levels of maturity mismatch, uncertainty about their fundamentals, and exposure to sovereign risk. The ban also caused a side effect on non-financial firms, since it led to an increase in their exposure to short sales, reflecting the existence of a common aggregate risk factor.

Short-Selling Bans and Bank Stability

In both the 2008-09 subprime crisis and the 2011-12 euro debt crisis, security regulators imposed bans on short sales, designed mainly with financial institutions in mind. The motivation was that a collapse in a bank’s stock price could lead to funding problems, triggering further price drops: the ban on shorting bank stocks was supposed to break this loop, stabilizing banks and bolstering their solvency. We test this hypothesis against evidence from both crises, estimating panel data regressions for 13,473 stocks in 2008 and 16,424 stocks in 2011 in 25 countries, taking the endogeneity of short-selling bans into account. Contrary to the regulators’ intentions, in neither crisis were the bans associated with increased bank stability. Instead, when financial institutions were subjected to a short-selling ban, they displayed larger share price drops, greater return volatility and higher probability of default. And the effects were more pronounced for the more vulnerable banks. Nor did the ban in 2011 do anything to mitigate the “diabolic loop” between bank and sovereign insolvency risk during the euro-area sovereign debt crisis.

Analysis of market quality before and during short-selling bans

We measure the impact of the August 2011 bans on covered short-selling adopted by several European countries. Our results provide evidence that the impact on prices was short-lived: the positive price impact disappears after ten days. The short-selling restrictions did not contribute to reduce the volatility of the financial stocks subjected to the bans; on the contrary, our findings indicate that volatility actually increased by a greater extent for these stocks than for other financial stocks with similar characteristics. The bans also had a negative impact on liquidity. Moreover, stocks subjected to the bans exhibit a longer delay in the assimilation of negative market news during the banning span.

Short-selling ban and cross-sectoral contagion: Evidence from the UK

The UK’s Financial Services Authority introduced a ban on the short-selling of specified financial-sector stocks in September 2008. The regulator’s stated objectives were to protect market quality, stabilise the market for financial-sector stocks, and prevent cross-sectoral contagion. We analyse the price, market quality and contagion effects following the imposition of the short-selling ban, and its removal in January 2009. We report evidence consistent with a short-lived overpricing (underpricing) effect immediately after the ban was imposed (lifted). There is evidence of deterioration in market quality while the ban was in force. There is evidence of cross-sectoral contagion from the financial sector to the telecommunication sector immediately before the imposition of the ban, but there is no contagion for seven other non-financial sectors. There is no evidence of contagion while the ban was in force. In terms of preventing cross-sectoral contagion, the ban may be seen as a successful governance mechanism in the regulator’s toolbox.