17 Apr 2009, Peter Madigan, Risk magazine
In a paper entitled 'The Undesirable Effects of Banning Short Sales', Abraham Lioui, a finance professor at the EDHEC Business School in Nice, analyses data from the US on the impact of the injunction preventing short selling of 799 financial stocks in September and October 2008, during the worst of the market turbulence.
Lioui found that while financial stocks predictably saw an increase in daily volatility during the crisis, their volatility increased still further after the ban on short-selling was enacted.
"Together, the crisis and the ban led to a multiplication by two to three of the daily volatility of the off-limits stocks. HSBC's daily volatility rose from 0.7% to 2.3%. On the other hand, CIC's volatility rose from 1.39% to only 1.8% per day after the short sale ban period. All in all, there is a systematic increase in volatility, although it does not increase homogeneously," Lioui noted in the paper.
The impact was not only observable in restricted stocks but also in equity markets as a whole, with the Nasdaq's daily volatility rising from 0.52% to 1.38% during the financial crisis and another 0.68 points to 2.06% after the short-selling ban took effect. The ban on short selling increased the daily volatility of the S&P 500 by 0.09 points, whereas the crisis increased it by only 0.02 points. Daily volatility on the FTSE 100 similarly increased 0.05 points during the ban but only 0.01 points during the crisis as a whole.
Lioui concluded that "the desired effect on market trends has not been achieved (no reduction of the negative skewness of returns is being observed) and there is no evidence of the possible impact of this measure on extreme market movements".
He also contended that while short sellers perhaps did not merit the punishment of simply banning the shorting of the shares of financial institutions, the study confirms the shares that were the object of the ban were relatively unaffected by it.
Lioui criticised the ban as a "drastic measure [that] casts the market authorities in a particularly negative light... the reasons for this measure are unclear, a lack of clarity that adds to the bewilderment of the market. The market, of course, reacted accordingly."
Although the US short-selling ban expired in October 2008, the Australian Securities and Investments Commission extended its injunction against short-selling financial stocks in March until May 31, and the issue is once again high on the regulatory agenda.
Last month, the International Organisation of Securities Commissions released a statement calling for co-ordination between national supervisors to regulate short selling, but did not advocate a particular method for doing so.
In March, William Brodsky, chief executive of the Chicago Board Options Exchange, told a conference that he expects Securities and Exchange Commission chair Mary Shapiro to issue a consultation paper on permanently prohibiting naked short-selling in the US within a matter of months.
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