The Undesireable Effects of Banning Short Sales by Advanced Trading

From the AdvanceTrading.com blog:

The Undesireable Effects of Banning Short Sales by Advanced Trading:

"...study of short-selling activities by... Abraham Lioui, entitled 'The Undesirable Effects of Banning Short Sales,' calls into question both the reasons for the decision to ban short selling and the prejudices that weigh on those who short.

Among the consequences of the ban:

* Market volatility rose sharply because there was no clarity on the reasons behind the measure.
* The impact of the ban on market volatility was greater than the impact of the financial crisis.
* Share prices deviated yet more from their fundamental value.
* The risk/return possibilities of investors worsened.
* 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."

Many of these points have been mentioned here before in the Bris 2008 piece, but still worth reading.

One of the interesting points in the paper were that the short-sale ban did not affect most of the "shorts":

"According to recently published data (for the United States in particular), a large majority of short sellers are market makers who are hedging their bets on the options markets. They were not affected by the ban, which means that those who were using options to take synthetic short positions continued to do so. The others involved in short selling are mainly hedge funds."

The author concludes with as a result of the short-sale ban there was a

"....rise in idiosyncratic risk and thus of the noise in the markets. As a consequence, share prices deviate yet more from their fundamental value. Finally, 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. What is clear is that stock market indices now have
components that are subject to different rules, differences that make them even less
representative and relevant."

What could have been done?

"...rather than opting for this facile response, greater efforts to democratise this market and to
increase its transparency should perhaps have been made."

The entire paper is available here.