Short Sale Ban Did Not Ease Downward Pressure in the Financial Markets, Says EDHEC

In a new position paper entitled ‘Spillover Effects of Counter-cyclical Market Regulation: Evidence from the 2008 Ban on Short Sales’, Professor Abraham Lioui, Professor of Finance at EDHEC Business School looks at the impact of the ban on broad market indices in the US and in Europe (the UK, France and Germany).

Since these indices and their performance are of great concern to the asset management and hedge fund industries, it is important for practitioners and policymakers to understand the impact of changing the rules of the game (banning short sales) on the return distribution of these indices and to assess the potential spillover effects of a counter-cyclical regulation affecting only one segment of the financial market.

Among the main conclusions of the study:

• The ban leads to a considerable increase in the dispersion of investor opinions and this dispersion, in turn, leads to great increases in the volatility of stocks and indices. This effect is evident even when such events as the Lehman Brothers bankruptcy and the longstanding sub-prime crisis are controlled for.
• Nor does the ban relieve the downward pressure on stock prices. Short selling does not migrate to the derivatives markets; the sustained fall of prices is, instead, the result of long traders exiting the market.
• The market does not seem to believe that short sellers or the hedge fund industry were responsible for the turmoil of 2008.

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