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:
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.
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.
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.
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.