Short‐Selling Bans Around the World: Evidence from the 2007–09 Crisis

TLDR: 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.

Figures

Table 10. Returns and Short-Selling Bans

Table 5. Bid-Ask Spreads and Short-Selling Bans: Differential Effects by Size and Volatility

Figure 6. Ratio between Average Bid-Ask Spread for Stocks With and Without Ban in Canada and the U.S.

Figure 7. Ratio between Average Bid-Ask Spread for Stocks With and Without Ban in Switzerland and the U.K.

Table 6. Bid-ask Spreads and Short-Selling Bans: Country-by-Country Estimates

Table 2. Median Bid-Ask Spreads Before, During and After Short-Selling Bans

Full text

Duisenberg school of finance - Tinbergen Institute Discussion Paper
TI 10-106 / DSF 1
Short-Selling Bans around the World
Alessandro Beber
1,3,4
Marco Pagano
2,3
1
Duisenberg school of finance, University of Amsterdam;
2
Università di Napoli Federico II, CSEF, EIEF;
3
CEPR;
4
Tinbergen Institute.

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2
Short-Selling Bans around the World:
Evidence from the 2007-09 Crisis
Alessandro Beber
Duisenberg school of finance, University of Amsterdam and CEPR
Marco Pagano
Università di Napoli Federico II, CSEF, EIEF and CEPR
Abstract
Most stock exchange regulators around the world reacted to the 2007-2009 crisis by
imposing bans or regulatory constraints on short-selling. Short-selling restrictions were
imposed and lifted at different dates in different countries, often applied to different sets of
stocks and featured different degrees of stringency. We exploit this considerable variation
in short-sales regimes to identify their effects with panel data techniques, and find that bans
(i) were detrimental for liquidity, especially for stocks with small market capitalization,
high volatility and no listed options; (ii) slowed down price discovery, especially in bear
market phases, and (iii) failed to support stock prices, except possibly for U.S. financial
stocks.
JEL classification: G01, G12, G14, G18.
Keywords: short selling, ban, crisis, liquidity, price discovery.
Acknowledgements: We thank Viral Acharya, Bruno Biais, Dimitris Christelis, Anne de
Graaf, Joost Driessen, Charles Jones, Ailsa Röell, Enrique Schroth, Erik Theissen, Tullio
Jappelli and seminar participants at the 2009 NYSE-Euronext-Tinbergen Institute
Workshop on “Liquidity and Volatility in Today’s Markets”, at the University of Naples
Federico II and at the Autoritaet Financiële Markten. Richard Evers, Martijn Reekers and
Piyush Singh provided outstanding research assistance. Financial support from Inquire
Europe and Q-Group is gratefully acknowledged.

3
“The emergency order temporarily banning short selling of financial stocks will
restore equilibrium to markets” (Christopher Cox, SEC Chairman, 19 September
2008, SEC News Release 2008-211).
“Knowing what we know now, I believe on balance the commission would not do
it again. The costs (of the short-selling ban on financials) appear to outweigh the
benefits.” (Christopher Cox, telephone interview to Reuters, 31 December 2008).
1. Introduction
Most stock exchange regulators around the world reacted to the financial crisis of 2007-
2009 by imposing bans or regulatory constraints on short-selling by market participants.
These hurried interventions, which in many countries were selective and varied
considerably in intensity and duration, were presented as measures to restore the orderly
functioning of securities markets and limit unwarranted drops in securities prices.
However, theoretical reasons and previous evidence cast doubt on the benefits of short-
selling bans, in particular for the liquidity and the price discovery function of securities
markets. Since the crisis was accompanied by a steep increase in bid-ask spreads in stock
markets, it is important to understand whether and to what extent short-selling bans
contributed to their increase. If one were to conclude that, far from restoring “orderly
market conditions” as claimed by policy makers, these interventions actually reduced
market liquidity, this would be a serious indictment of their adoption, especially
considering that they were enacted at a time when market participants desperately sought
liquidity on stock markets, due to the freeze of the structured debt and interbank markets.
In this paper we bring the large amount of evidence generated by the crisis to bear on
this issue: the flurry of short-selling bans generated a wealth of data that can be used to
investigate their effects on market liquidity, on the speed of price discovery and on stock
prices. Short-sale restrictions were imposed and lifted at different dates in different
countries; they often applied to different sets of stocks (only financials in some countries,
all stocks in others) and featured different degrees of stringency: all these features make the
data ideally suited to identify the effects of the bans through panel data techniques.

4
While the primary focus of our study is on market liquidity, we also investigate the
effects of short-selling bans on other dimensions of market performance considered in the
literature, such as price discovery and the level of stock prices. Our sample consists of daily
data for 16,491 stocks from 30 countries, for the period spanning from January 2008 to June
2009. For each country, we ascertain whether a short-selling ban was enacted in this interval,
and if so when the ban was introduced and lifted, which stocks it applied to, and which
restrictions it imposed on short sales.
Since the literature suggests that bid-ask spreads differ across stocks, due to their risk
characteristics, average trading volume, number of market makers, and so on, in the
estimation we use stock-level fixed effects to control for time-invariant stock
characteristics. We also control for return volatility, since its changes may affect bid-ask
spreads by changing the inventory risk of market makers. Finally, in some specifications
we control also for common changes in liquidity by including day fixed effects and other
time-varying crisis-related factors, to take into account commonality in liquidity, especially
in view of the fact that during the crisis increased uncertainty and acute funding problems
are likely to have reduced stock market liquidity throughout the world.
Our results indicate that the short-selling bans imposed during the crisis are associated
with a statistically and economically significant increase in bid-ask spreads, controlling for
other variables. Instead, the obligation to disclose short sales is associated with a significant
decrease in bid-ask spreads. The same effects are found when illiquidity is measured by the
Amihud illiquidity indicator.
We also investigate whether these negative effects on liquidity disproportionately affect
stocks with some characteristics, and find that that they are more pronounced for small-cap
and more volatile stocks. As a result, in countries where such stocks are overrepresented
the bans are associated with larger increases in bid-ask spreads. Moreover, the adverse
liquidity effect of bans is stronger for stocks that do not have listed options than for stocks
that do, consistently with the idea that the availability of an option market allows investors
to effectively express short views on the underlying stock affected by the ban. For the
dually listed stocks in our sample, short-selling bans in the home market increase bid-ask

Frequently asked questions

Q1. What contributions have the authors mentioned in the paper "Ti 10-106 / dsf 1 short-selling bans around the world" ?

The authors exploit this considerable variation in short-sales regimes to identify their effects with panel data techniques, and find that bans ( i ) were detrimental for liquidity, especially for stocks with small market capitalization, high volatility and no listed options ; ( ii ) slowed down price discovery, especially in bear market phases, and ( iii ) failed to support stock prices, except possibly for U. S. financial stocks. 

Q2. What is the effect of a short-selling ban on the price discovery?

By restraining the trading activity of informed traders with negative information about fundamentals, a short-selling ban should slow down price discovery, and more so in bear market phases. 

Q3. What is the effect of a short-selling ban on price discovery?

Since short-selling bans are intended to limit the activity of investors with bearish views, they should slow price discovery more in overall declining markets than in rising ones. 

Q4. What is the effect of short selling bans in countries with a larger fraction of small-?

The authors also include the concentration of stock ownership, because stocks with more concentrated ownership feature less floating shares, and therefore lower liquidity; hence the authors expect the effect of short-selling bans to be more dramatic in such countries. 

Q5. What are the characteristics of the determinants of the bid-ask spread?

Since models of the bid-ask spread based on adverse selection and inventory holding risk suggest that risk is a potentially important determinant of bid-ask spread, in some specifications the authors also control for the changing stock-level volatility of returns. 

Q6. What is the effect of the requirement that short selling be executed only on an up tick in 1938?

Jones and Lamont (2002), who investigate the change in liquidity around events during the Great Depression that altered the level of short-sale constraints in the U.S., find that the introduction of the requirement that brokers secure written authorization before lending a customer’s shares in 1932 had a negative impact on liquidity, but the requirement that short selling be executed only on an up tick in 1938 had a positive effect on liquidity. 

Q7. How large was the bid-ask spread during the ban period?

In the four countries that first lifted the ban (Canada, Switzerland, U.K. and U.S.) the bid-ask spread during the ban period was on average 1.5 times as large as its post-ban value. 

Q8. What is the effect of a short selling ban on the speed of price discovery?

The predicted effect of short-selling bans on the speed of price discovery is more clear-cut than it is for liquidity, as should be clear from the above discussion of the DiamondVerrecchia (1987) model: by preventing traders from short selling, a ban moderates the trading activity of informed traders who have negative information about fundamentals and thereby slows down price discovery, and does so asymmetrically – more in bear than in bull markets. 

Q9. What is the median bid-ask spread for financial stocks during the ban period?

The median bid-ask spread for financial stocks rose from 0.0853 in the pre-ban period to 0.0957 in the covered ban period and reverted to 0.0800 after the ban lift. 

Q10. How do the authors de-mean the variables at the firm level?

To ease the burdensome computational task of computing firm fixed effects and day effects all at once, the authors first de-mean all the variables at the firm-level and then perform a panel regression with day fixed effects. 

Q11. How much is the median bid-ask spread for stocks subject to the ban?

The median bid-ask spread for stocks subject to the naked ban only (from 22 September 2008 to 4 October 2008) is 0.3075, about 1.4 times the median bid-ask spread before the ban. 

Q12. What are the main factors that are warranted by the inclusion of size and volatility?

The inclusion of size and volatility is warranted by the results of Table 5, which suggest that the effect of shortselling bans should be stronger in countries with a larger fraction of small-cap and volatile stocks. 

Q13. What is the effect of a short selling ban on bid-ask spreads?

when market participants are risk-averse, the predicted effect of a short-selling ban on bid-ask spreads is more clear-cut than in the Glosten-Milgrom setting with adverse selection.