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Banning short sales and market quality: The UK’s experience

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  • Marsh, Ian W.
  • Payne, Richard

Abstract

We study the effects that the ban on short sales of shares in financial firms introduced in late 2008 and removed early 2009 had on the microstructure and the quality of UK equity markets. We show that the ban did nothing to affect order flows: financial stocks were being more aggressively sold off than their peers pre-ban and this situation persisted through the ban period. Trading volume in financials was massively reduced, however. The ban decimated order book liquidity for financials. The deterioration was symmetric, affecting the limit buy and limit sell side of the order book equally. Finally we show that, through the period of the ban, markets for financial stocks were substantially less efficient and that the role of the trading process in aiding price discovery was greatly reduced. The effects identified above were largely reversed once the ban was lifted. The persistence of the deterioration in market quality and liquidity though the relatively long-lasting UK ban on short selling suggests that other major market developments such as the TARP program were not responsible since these were concentrated in the early half of the ban. We thus argue that the short selling ban was responsible for detrimental effects on the quality of UK equity markets and that, far from being stabilising, the ban exacerbated problems in valuing UK financial stocks.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 36 (2012)
Issue (Month): 7 ()
Pages: 1975-1986

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Handle: RePEc:eee:jbfina:v:36:y:2012:i:7:p:1975-1986

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Web page: http://www.elsevier.com/locate/jbf

Related research

Keywords: Short-selling; Liquidity; Market efficiency;

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References

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  1. Diamond, Douglas W. & Verrecchia, Robert E., 1987. "Constraints on short-selling and asset price adjustment to private information," Journal of Financial Economics, Elsevier, vol. 18(2), pages 277-311, June.
  2. Arturo Bris & William N. Goetzmann & Ning Zhu, 2007. "Efficiency and the Bear: Short Sales and Markets Around the World," Journal of Finance, American Finance Association, vol. 62(3), pages 1029-1079, 06.
  3. Markus K Brunnermeier & Lasse Heje Pederson, 2003. "Predatory Trading," FMG Discussion Papers dp441, Financial Markets Group.
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  5. Miller, Edward M, 1977. "Risk, Uncertainty, and Divergence of Opinion," Journal of Finance, American Finance Association, vol. 32(4), pages 1151-68, September.
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  7. Sylvain Friederich & Richard Payne, 2007. "Dealer Liquidity in an Auction Market: Evidence from the London Stock Exchange," Economic Journal, Royal Economic Society, vol. 117(522), pages 1168-1191, 07.
  8. Marianne Bertrand & Esther Duflo & Sendhil Mullainathan, 2002. "How Much Should We Trust Differences-in-Differences Estimates?," NBER Working Papers 8841, National Bureau of Economic Research, Inc.
  9. Saffi, Pedro & Sigurdson, Kari, 2008. "Price efficiency and short selling," IESE Research Papers D/748, IESE Business School.
  10. Hasbrouck, Joel, 1991. " Measuring the Information Content of Stock Trades," Journal of Finance, American Finance Association, vol. 46(1), pages 179-207, March.
  11. Yadav, Pradeep K. & Fotak, Veljko & Raman, Vikas, 2009. "Naked short selling: The emperor`s new clothes?," CFR Working Papers 09-09, University of Cologne, Centre for Financial Research (CFR).
  12. Karl B. Diether & Kuan-Hui Lee & Ingrid M. Werner, 2009. "Short-Sale Strategies and Return Predictability," Review of Financial Studies, Society for Financial Studies, vol. 22(2), pages 575-607, February.
  13. Eli Ofek & Matthew Richardson & Robert F. Whitelaw, 2003. "Limited Arbitrage and Short Sales Restrictions: Evidence from the Options Markets," NBER Working Papers 9423, National Bureau of Economic Research, Inc.
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Cited by:
  1. Óscar Arce & Sergio Mayordomo, 2012. "Short Sales Constraints and Financial Stability: Evidence from the Spanish 2011 Ban," Faculty Working Papers 25/12, School of Economics and Business Administration, University of Navarra.
  2. Bohl, Martin T. & Klein, Arne C. & Siklos, Pierre L., 2013. "Are short sellers positive feedback traders? Evidence from the global financial crisis," Journal of Financial Stability, Elsevier, vol. 9(3), pages 337-346.

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