Shackling short sellers: the 2008 shorting ban
TL;DR: This paper examined the effect of short sales on market quality, shorting activity, the aggressiveness of short sellers, and stock prices in financial stocks and found that the short sellers' effect was concentrated in larger stocks and little effect on firms in the lower half of the size distribution.
Abstract: In September 2008, the U.S. Securities and Exchange Commission (SEC) temporarily banned most short sales in nearly 1,000 financial stocks. We examine the ban's effect on market quality, shorting activity, the aggressiveness of short sellers, and stock prices. The ban's effects are concentrated in larger stocks; there is little effect on firms in the lower half of the size distribution. Although shorting activity drops by about 77% in large-cap stocks, stock prices appear unaffected by the ban. All but the smallest quartile of firms subject to the ban suffer a severe degradation in market quality. The Author 2013. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.
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TL;DR: In this article, the authors exploit the variation in short-sales regimes to identify their effects on liquidity, price discovery, and stock prices, and find that bans are detrimental for liquidity, especially for stocks with small capitalization and no listed options.
Abstract: Most regulators around the world reacted to the 2007–09 crisis by imposing bans on short selling. These were imposed and lifted at different dates in different countries, often targeted different sets of stocks, and featured varying degrees of stringency. We exploit this variation in short-sales regimes to identify their effects on liquidity, price discovery, and stock prices. Using panel and matching techniques, we find that bans (i) were detrimental for liquidity, especially for stocks with small capitalization and no listed options; (ii) slowed price discovery, especially in bear markets, and (iii) failed to support prices, except possibly for U.S. financial stocks.
348 citations
TL;DR: In this article, the SEC ordered a pilot program in which one-third of the Russell 3000 index were arbitrarily chosen as pilot stocks and exempted from short-sale price tests, and the results indicate that short selling or its prospect, curbs earnings management, helps detect fraud, and improves price efficiency.
Abstract: During 2005 to 2007, the SEC ordered a pilot program in which one-third of the Russell 3000 index were arbitrarily chosen as pilot stocks and exempted from short-sale price tests. Pilot firms’ discretionary accruals and likelihood of marginally beating earnings targets decrease during this period, and revert to pre-experiment levels when the program ends. After the program starts, pilot firms are more likely to be caught for fraud initiated before the program, and their stock returns better incorporate earnings information. These results indicate that short selling, or its prospect, curbs earnings management, helps detect fraud, and improves price efficiency.
226 citations
TL;DR: In this article, Liu et al. find that stocks experience negative returns when added to the short-sellers' list and that intensified short-selling activities are associated with improved price efficiency.
Abstract: China launched a pilot scheme in March 2010 to lift the ban on short-selling and margin-trading for stocks on a designated list. We find that stocks experience negative returns when added to the list. After the ban is lifted, price efficiency increases while stock return volatility decreases. Panel data regressions reveal that intensified short-selling activities are associated with improved price efficiency. Short-sellers trade to eliminate overpricing by selling stocks with higher contemporaneous returns following a downward trend, and their trades predict future returns. In contrast, we find intensified margin-trading activities for stocks with lower contemporaneous returns, and these trades have no return predictive power.
178 citations
TL;DR: In this paper, the authors develop a methodology to infer the amount of capital allocated to quantitative equity arbitrage strategies, which exploits time-variation in the cross-section of short interest.
Abstract: We develop a novel methodology to infer the amount of capital allocated to quantitative equity arbitrage strategies. Using this methodology, which exploits time-variation in the cross-section of short interest, we document that the amount of capital devoted to value and momentum strategies has grown significantly since the late 1980s. We provide evidence that this increase in capital has resulted in lower strategy returns. However, consistent with theories of limited arbitrage, we show that strategy-level capital flows are influenced by past strategy returns and strategy return volatility and that arbitrage capital is most limited during times when strategies perform best. This suggests that the growth of arbitrage capital may not completely eliminate returns to these strategies. (JEL G02, G12, G14, G23)
141 citations
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TL;DR: In this paper, the authors show that stocks with more short selling risk have lower returns, less price efficiency, and less short selling, and that these short selling risks affect prices among the cross-section of stocks.
Abstract: Short sellers face unique risks, such as the risk that stock loans become expensive and the risk that stock loans are recalled. We show that these short selling risks affect prices among the cross-section of stocks. Stocks with more short selling risk have lower returns, less price efficiency, and less short selling.
108 citations
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TL;DR: In this article, a parameter covariance matrix estimator which is consistent even when the disturbances of a linear regression model are heteroskedastic is presented, which does not depend on a formal model of the structure of the heteroSkewedness.
Abstract: This paper presents a parameter covariance matrix estimator which is consistent even when the disturbances of a linear regression model are heteroskedastic. This estimator does not depend on a formal model of the structure of the heteroskedasticity. By comparing the elements of the new estimator to those of the usual covariance estimator, one obtains a direct test for heteroskedasticity, since in the absence of heteroskedasticity, the two estimators will be approximately equal, but will generally diverge otherwise. The test has an appealing least squares interpretation.
25,689 citations
TL;DR: The authors showed that bank deposit contracts can provide allocations superior to those of exchange markets, offering an explanation of how banks subject to runs can attract deposits, and showed that there are circumstances when government provision of deposit insurance can produce superior contracts.
Abstract: This paper shows that bank deposit contracts can provide allocations superior to those of exchange markets, offering an explanation of how banks subject to runs can attract deposits. Investors face privately observed risks which lead to a demand for liquidity. Traditional demand deposit contracts which provide liquidity have multiple equilibria, one of which is a bank run. Bank runs in the model cause real economic damage, rather than simply reflecting other problems. Contracts which can prevent runs are studied, and the analysis shows that there are circumstances when government provision of deposit insurance can produce superior contracts.
9,099 citations
TL;DR: In this paper, the authors explore the implications of a market with restricted short selling in which investors have differing estimates of the returns from investing in a risky security, and explain the very low returns on the stocks in the highest risk classes, the poor long run results on new issues of stocks, the presence of discounts from net value for closed end investment companies, and the lower than predicted rates of return for stocks with high systematic risk.
Abstract: THE THEORY OF investor behavior in a world of uncertainty has been set out by several writers including Sharpe (1964) and Lintner (Feb. 1965). A key assumption of the now standard capital asset model is what Sharpe calls homothetic expectations. All investors are assumed to have identical estimates of the expected return and probability distribution of return from all securities. However, it is implausible to assume that although the future is very uncertain, and forecasts are very difficult to make, that somehow everyone makes identical estimates of the return and risk from every security. In practice, the very concept of uncertainty implies that reasonable men may differ in their forecasts. This paper will explore some of the implications of a market with restricted short selling in which investors have differing estimates of the returns from investing in a risky security.' Explanations will be offered for the very low returns on the stocks in the highest risk classes, the poor long run results on new issues of stocks, the presence of discounts from net value for closed end investment companies, and the lower than predicted rates of return for stocks with high systematic risk.
3,436 citations
TL;DR: In this paper, the authors evaluate alternative methods for classifying individual trades as market buy or market sell orders using intraday trade and quote data and identify two serious potential problems with this method, namely, that quotes are often recorded ahead of the trade that triggered them and that trades inside the spread are not readily classifiable.
Abstract: This paper evaluates alternative methods for classifying individual trades as market buy or market sell orders using intraday trade and quote data. We document two potential problems with quote-based methods of trade classification: quotes may be recorded ahead of trades that triggered them, and trades inside the spread are not readily classifiable. These problems are analyzed in the context of the interaction between exchange floor agents. We then propose and test relatively simple procedures for improving trade classifications. THE INCREASING AVAILABILITY OF intraday trade and quote data is opening new frontiers for financial market research. The improved ability to discern whether a trade was a buy order or a sell order is of particular importance. In Hasbrouck (1988), the classification of trades as buys or sells is used to test asymmetric-information and inventory-control theories of specialist behavior. In Blume, MacKinlay, and Terker (1989), a buy-sell classification is used to measure order imbalance in tests of breakdowns in the linkage between S&P stocks and non-S&P stocks during the crash of October, 1987. In Harris (1989), an increase in the ratio of buys to sells is used to explain the anomalous behavior of closing prices. In Lee (1990), the imbalance in buy-sell orders is used to measure the market response to an information event. In Holthausen, Leftwich, and Mayers (1987), a buy-sell classification is used to examine the differential effect of buyer-initiated and seller-initiated block trades. Most past studies have classified trades as buys or sells by comparing the trade price to the quote prices in effect at the time of the trade. In this paper, we identify two serious potential problems with this method, namely, that quotes are often recorded ahead of the trade that triggered them, and that
3,301 citations
TL;DR: In this paper, the effects of short-sale constraints on the speed of adjustment (to private information) of security prices are modeled. But short-sellers do not bias prices upward, while non-prohibitive costs have the reverse effect.
1,866 citations