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Monday, August 15th, 2011

What the short-selling ban really says posted by Ross Dawkins

Belgium, France, Italy and Spain have now implemented short-selling bans on bank and insurance stocks.  It’s too early to say much directly about the effects of this decision (trades in place at its implementation are still unwinding for example) but the evidence available about other shorting bans makes this a curious call.  Christopher Cox’s quote that an equivalent measure in 2008 was his biggest regret as SEC Chairman has been much cited.  Recent work by Boehmer and colleagues found that the ban did result in a sharp reduction in shorting itself — but that market quality worsened and short-term volatility increased as a result of the ban.  These were the opposite of the desired result.  Similarly, Saffi and Sigurdsson (looking globally rather than just at the USA experience) highlight that short-selling constraints are associated with reduced price efficiency in the affected stocks. 

So what does this ban say about the policy-makers? 

There are a few possibilities.  First, that there is an ignorance of the research on the subject — I think this is highly unlikely.  Second, that either there is an expectation that reality will re-configure itself to the desires of the policy-makers or else that micro-structural differences between European and US markets will make some difference.  This is possible but represents faulty reasoning.  We are left with a third possibility — that there is a preference for making gestures over making a difference.  This may well be reinforced by a desire to make life more difficult for those employing short-selling strategies (let’s say hedge funds and investment banks, although these are not the only ones).  

Given a context of an outstanding need for clear political leadership in Europe this posturing sends an unfortunate signal to the markets and to the citizens of Europe.

Sources:

Pedro A C Saffi and Kari Sigurdsson (2011), "Price Efficiency and Short Selling", The Review of Financial Studies, Volume 24/3, pages 821-853

Ekkehart Boehmer, Charles M Jones and Xiaoyan Zhang (2011), “Short Selling: Recent Evidence”, EDHEC Business School Working Paper

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