Impact of the Short Sale Ban
When France, Belgium, Italy and Spain implemented the short sale ban on Aug. 12, trading volume in financial names in those markets decreased dramatically. Volume in financials in markets without the bans continued to be elevated, though not to the extent that it was during the “base period”2 prior to the volatile period (Figure 3).
Since the short sale ban, financial names in the countries with the ban have performed similarly to financials in countries with no ban. Comparing the performance of financial names in a particular country to the performance of that country’s market overall, we also see no distinguishable difference between countries with the ban and countries without (Figure 4).
In all the countries studied, the degree of average daily price moves (in either direction) increased over the volatile period and fell during the short sale ban period. Figure 5 shows the change in the size of price moves in the banned period compared to the volatile period. The changes are negative, indicating that the average absolute price move decreased after the volatile period. If the short sale bans succeeded in reducing volatility, one would expect the reduction of price volatility to be greater in countries with the ban than without. In fact, the reduction in volatility between the two groups is similar.
Bid-ask spreads in financials increased in the volatile period and decreased in the “post-volatility period”3 in every country except Spain (Figure 6). There is no consistent difference between the decrease in the banned countries and the decrease in the other countries and thus no indication that the short sale ban was negative for spreads.
Finally, we note that several pieces of academic research support our hypothesis that the recent short sale bans have harmed liquidity without lessening volatility:
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Beber and Pagano (2009) examined the varying regulatory constraints globally during the 2008 crisis and found that short sale bans harmed liquidity, did not support price discovery and did not generally support stock prices.
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Boehmer, Jones and Zhang (2009) examined the impact of the Securities and Exchange Commission’s 2008 ban on the short selling of financial names in the U.S. They found that the ban harmed market quality by increasing spreads and volatility, and found inconclusive evidence of the impact of the ban on prices.
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Harris, Namvar and Phillips (2009) looked at the 2008 bans globally and found evidence that they reduce negative skewing at a market level but do not make a difference at an individual stock level. The group also found positive abnormal returns for U.S. financial names under a short sale ban. The ambiguity between these two studies may be attributable to the difficulty of separating the impact of the ban from the impact of the announcement of the U.S. bank bail-out program.
The clearest evidence from the data is that volume falls dramatically when a short sale ban is in effect while names in markets without a similar ban trade actively. This is a concern as it implies that liquidity has been dramatically inhibited, possibly because many of the short sellers were providing liquidity using market-making strategies. There is no indication that price performance is protected under the bans. Ultimately, we do not believe that the recent short sale bans have succeeded in protecting markets from extreme volatility and if anything have harmed market quality.
A Note on Methodology
Stocks analyzed in this study were weighted by average daily value traded (composite) during the review periods, and spreads were weighted by market capitalization.
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1“Volatile Period” defined as August 3-11, 2011.
2“Base Period” defined as July 21-August 2, 2011.
3“Post-Volatility Period” defined as August 12-29, 2011.
Comments | Post a Comment
10 Comments to "Short Sale Bans: How Effective Are They?":
shamlet76
03 October 2011
your article is based on shares marked "short". shortsellers sell short or long, they don't care. this is because you have the dynamic of correspondent brokers, which are brokers that gain access to the market through other brokers. those correspondent brokers have much less interest in following market rules than the licensed broker who is in that market.
the correspondent broker can offer a lower margin, does not filter orders for borrowing shares, does not follow clearing or settlement rules for the customer.
subaccount trading, avoiding market rules:
http://www.securitiestechnologymonitor.com/news/subaccounts-trading-sec-rules-29155-1.html
with brokers who do not follow market rules, are you going to get statistics that are skewed? i think so.
worse, it appears that there is an additional problem of counterfeit certificates.
Comments (149)
asussman
04 October 2011
Alison, for figure 3 are you looking at notional volume, trade volume or share volume? Thx, Adam
Comments (159)
lberke
04 October 2011
It is possible that, as shamlet76 posits, that not all trades are accurately tagged as short sales. However, given the drop in volumes (and per Adam's question, which volume are you showing?) it's clear that a large component of sell side flow left these names once the ban was put in place. More importantly and more interesting, as you said in your video, it's surprising that spreads were not negatively impacted by the absence of short sellers & certain arbitrage strategies. Would you venture an explanation as to why?
Comments (129)
Anonymous
05 October 2011
Simple - the vast majority of short sellers are HFTs...they go away and volume goes down, but the real liquidity metrics of spread and volatility aren't harmed....wow, turns out the HFTs really just add noise...who'd of thunk it? /thread.
lberke
05 October 2011
HFT is a trading style, not a trading strategy. If the regulators place short sale restrictions on certain securities, that doesn't remove HFT from those stocks, it simply removes certain trading strategies that rely upon short sales.
Comments (129)
Anonymous
05 October 2011
yes - HFT is a trading style that relies heavily on the ability to short....banning short removes many HFT players. volume fell but vol and spread stayed relatively flat...leading to the question what value does this added volume really contribute? discuss amongst ourselves....
lberke
05 October 2011
I can tell you that some head traders at some very large buy-side asset management firms would tell you that the additional volume is good. So, if there's more volume at the same level of volatility & spread, there are some very knowledgeable traders who would say that some portion of this additional HFT volume is both accessible & valuable to them.
Comments (129)
crosthea
05 October 2011
Hi Laurie - I use share volume in this report. I can only hypothesize here but it looks like the ban impacted a certain class of strategies that are not the large market makers (because spreads didn't significantly change) and are not long term/macro investors (because price performance was not significantly different between banned and non banned financials). These could be a range of quantitative and medium term strategies as well as short term aggressive strategies - it is hard to pinpoint exactly without resorting to anecdotal evidence.
Comments (2)
amartinez
05 October 2011
I am not in favor of eliminating "short" sales. "Short" sales provide a benefit to the marlets. I am, however, in preventing the use of "short" sales in a manipulative manner. Prior to electronic trading the "uptick" rule prohobited a short sale below the last previous sale. The SEC conducted a study to see if eliminating such rule would be detrimental to the market place. The only problem was that the study was conducted during one of the market's most prolific increases in valuation - DOW moving from about 12,000 to about 14,000. With the advent of trading in pennies and electronic trading, it is extremely difficult for the old "uptick" rule to survive but the use of the "short" sale in a manipulative fashion destroys the confience of investors in our market place and increases volatility since why should anyone step in to buy in the midst of a short sale onslaught and publicly traded corporations shake at the sight of such market behavior -- to me, the current price controls regarding short sales are not enough to build investor and company confidence.
Comments (17)
lberke
05 October 2011
Hi Alison - Thanks for the clarification on volume. I would agree with you re: market makers & macro strategies, as they continued to maintain a consistent spread. I would venture a guess that some of the quant strategies that could no longer operate were momentum / trend based.
Comments (129)