Which short selling ban is least damaging?
07 February 2012 Brussels
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A new academic study argues that a ban on naked short selling is the least damaging to market efficiency of all short selling regulations.
Looking at European regulations between July 2008 and June 2009, researchers from the University Libre de Bruxelles found that covered short selling bans raise bid-ask spreads and reduce trading volumes, disclosure requirements raise volatility and reduce trading volumes while naked short selling bans raise both volatility and bid-ask spreads. In addition, the researchers assert that no regulations are effective against price decline.
“Overall, all short sale regulations are detrimental to market efficiency. However, naked short selling prohibition is the only regulation that leaves volumes unchanged while addressing the failure to deliver. Therefore, we argue that this is the least damaging to market efficiency,” the study said.
Researchers analysed fourteen European markets over the one-year period, studying the effects of a variety of regulatory regimes on market efficiency. They compared the effects of three categories of short selling regulations – prohibitions on covered and naked short selling, naked short selling only and requirements to disclose short positions to the market’s regulator - on individual stocks’ bid-ask spreads, intraday volatility, trading volume and weekly returns.
Though covered short selling prohibitions are associated with higher returns and lower intraday volatility, the effects are transitory the study showed. Meanwhile, naked short selling bans permanently raise intraday volatility and bid-ask spreads but have no impact on either volumes or stock returns, even in the short run. Disclosure requirements, meanwhile, reduce trading activity and increase volatility, also permanently.
Still, the study does point out that disclosure regulation regimes result in lower bid-ask spreads, as was the case during the financial crisis, when information to the market is likely most beneficial to efficiency. This could indicate that disclosure requirements increase reporting costs which uninformed short sellers shy away from.
“Hence, sell trades become more informative because they more likely originate from well-informed short sellers. Lower bid-ask spreads could also indicate that the informational benefit of disclosure outweighs the informational loss stemming from missing short sales,” the study said.
Other findings show that in the long run, stock returns are insensitive to short selling regulations though there is a short-term overvaluation effect, which can be “exploited by market authorities in crisis situations”.
“As far as market efficiency is concerned, our results thus raise serious doubts on the adequacy of both the existing national regulations and the pan-European proposed harmonisation currently under discussion,” noted researchers.
Looking at European regulations between July 2008 and June 2009, researchers from the University Libre de Bruxelles found that covered short selling bans raise bid-ask spreads and reduce trading volumes, disclosure requirements raise volatility and reduce trading volumes while naked short selling bans raise both volatility and bid-ask spreads. In addition, the researchers assert that no regulations are effective against price decline.
“Overall, all short sale regulations are detrimental to market efficiency. However, naked short selling prohibition is the only regulation that leaves volumes unchanged while addressing the failure to deliver. Therefore, we argue that this is the least damaging to market efficiency,” the study said.
Researchers analysed fourteen European markets over the one-year period, studying the effects of a variety of regulatory regimes on market efficiency. They compared the effects of three categories of short selling regulations – prohibitions on covered and naked short selling, naked short selling only and requirements to disclose short positions to the market’s regulator - on individual stocks’ bid-ask spreads, intraday volatility, trading volume and weekly returns.
Though covered short selling prohibitions are associated with higher returns and lower intraday volatility, the effects are transitory the study showed. Meanwhile, naked short selling bans permanently raise intraday volatility and bid-ask spreads but have no impact on either volumes or stock returns, even in the short run. Disclosure requirements, meanwhile, reduce trading activity and increase volatility, also permanently.
Still, the study does point out that disclosure regulation regimes result in lower bid-ask spreads, as was the case during the financial crisis, when information to the market is likely most beneficial to efficiency. This could indicate that disclosure requirements increase reporting costs which uninformed short sellers shy away from.
“Hence, sell trades become more informative because they more likely originate from well-informed short sellers. Lower bid-ask spreads could also indicate that the informational benefit of disclosure outweighs the informational loss stemming from missing short sales,” the study said.
Other findings show that in the long run, stock returns are insensitive to short selling regulations though there is a short-term overvaluation effect, which can be “exploited by market authorities in crisis situations”.
“As far as market efficiency is concerned, our results thus raise serious doubts on the adequacy of both the existing national regulations and the pan-European proposed harmonisation currently under discussion,” noted researchers.
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