Great WSJ Article on Effects of Short-Sale Ban
Back on September 29, Arturo Bris had a great piece in the Wall Street Journal on the counterproductive effects of the SEC’s ban on short-selling financial stocks. As readers of this blog know full well, I have been pounding on the fact that the ban will actually make prices more volatile (here’s an example from back in August).
The benefit of Bris’ analysis is that he actually looked at statistical tests and found that volatility went up, etc. after the ban. This is just textbook stuff. Thanks Paulson for proving that freedom works! Maybe you and Bush are really doing all this as a lesson to glorify the Invisible Hand. An excerpt:
What follows is a snapshot of the landscape before the SEC took action, and then the subsequent findings from my study of the 799 stocks initially covered in the ban. First, the “before” trends:
– Short selling activity was not excessively high for the 799 stocks from January to the ban’s start. While the percentage of short sales to total shares outstanding hit 19.1% in March, that percentage fell to 14.8% in July, when the sector’s stock prices experienced the greatest drops since March 2007. From Sept. 1 to Sept. 12, short sales in the 799 stocks amounted to a low 6% of shares outstanding. Short sales in relation to trading volume display the same pattern.
– Short-selling activity typically picked up after a stock fell in price, not generally before. Increases in short selling of individual stocks more often occurred the day after a sharp price drop, not before. This is consistent with research conducted by Karl Diether and Ingrid Werner of Ohio State University, and Kuan-Hui Lee of Rutgers, showing that short sellers trade in response to past negative news, and that they reveal information about forthcoming price drops. They may also want to protect their long positions from further declines by locking in prices through short sales.
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After the ban took effect last week, we saw a dramatic shift for the worse (market quality and stock liquidity declined) as investors found it increasingly difficult to hedge market risks.– Liquidity dried up. With lenders halting their stock loans, volume down and regulatory uncertainty high, less capital flowed into trading of the 799 stocks. Bid-ask spreads increased more for the 799 stocks than for the market overall.
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The intra-day trading range has almost doubled for the 799 stocks over the past week. This means that liquidity deteriorated. Less liquidity makes it more difficult for investors to trade without a severe market impact, and prices are less transparent.
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– Stocks reacted sluggishly to news. The 799 shares reacted more slowly to news than stocks outside the ban’s umbrella — a key sign of market inefficiency. In an efficient market, individual stocks should be affected primarily by company-specific news rather than overall market activity.Taken in full, the preliminary findings run counter to the SEC’s stated rational for imposing the ban.
