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Regulating noisy short-selling of troubled firms?

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Author Info

  • Carlos A Ulibarri
  • Ionut Florescu
  • Joel M Eidsath

Abstract

Purpose – The purpose of this paper is to examine the efficacy of recent policy initiatives taken by the US Securities and Exchange Commission banning naked “short-selling” of specific financial stocks. The paper also considers the merits of reinstating “uptick rule” 10a-1, which prohibits short-selling securities on a downtick. Design/methodology/approach – The paper studies theoretical implications of short-selling in a simple state-claim model, reflecting varying amounts of short interest in a representative firm and noise trading in the market. Price discovery depends on the proportion of noise trading compared to rational short-selling. The empirical analysis focuses on price volatility under short-selling constraints employing simple regressions, EGARCH analysis and simulated price behavior under a hypothetical uptick rule. Findings – The EGARCH results suggest short-selling constraints had non-uniform impacts on the persistence and leverage effects associated with price volatility. The corresponding price simulations indicate a hypothetical uptick rule might have helped stabilize price behavior in some cases, depending on the nature of the stochastic process and whether or not quantity constraints on short-selling are binding. Originality/value – The theoretical arguments and empirical findings suggest a “focused approach” to market regulation would be a more efficient means of discouraging trend chasing without compromising “informed trading” – that is to say, safeguarding price discovery and market liquidity without impeding arbitrage or confounding probability beliefs regarding firm survival. These conclusions are largely in accord with recent policy analysis and proposals outlined in Avgouleas.

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Bibliographic Info

Article provided by Emerald Group Publishing in its journal Journal of Financial Economic Policy.

Volume (Year): 1 (2009)
Issue (Month): 3 (May)
Pages: 227-245

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Handle: RePEc:eme:jfeppp:v:1:y:2009:i:3:p:227-245

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Related research

Keywords: Financial markets; Securities markets; Selling; United States of America;

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Cited by:
  1. Ulibarri, Carlos A., 2013. "Multivariate GARCH analysis of Fannie Mae, Freddie Mac, and American International Group: Did the short-selling ban reduce systemic return-risk?," The North American Journal of Economics and Finance, Elsevier, vol. 25(C), pages 60-69.
  2. Devaney, Michael, 2012. "Financial crisis, REIT short-sell restrictions and event induced volatility," The Quarterly Review of Economics and Finance, Elsevier, vol. 52(2), pages 219-226.

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