Market Frictions continued (short selling) - What do short sale bans do to market quality?

6 important questions on Market Frictions continued (short selling) - What do short sale bans do to market quality?

How might short selling bans affect markets?

  • Illiquidity (bid-ask spread): ambiguous
    • Measure: bid-ask spread and Amihud measure
  • Speed of price discovery: goes down
    • Measure: Correlation of individual stock returns with past market returns
  • Overpricing: ambiguous
    • Excess returns
  • (Ban dummies):
    • Measure: naked, covered, discolusure

Short selling bans: illiquidity

  • Increase: uncertainty about fundamentals
  • Decrease: Less informed traders decreases adverse selection
  • Increase: Higher inventory risk

Speed of price discovery: goes down

  • Negative: (Negative) information is impounded slower
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What are the regression results on liquidity (bid-ask)?

  • Bans decrease liquidity
  • Disclosure increases liquidity

If you ban naked short selling -> bid-ask increases, liquidity decreases

What are the results of bans on  liquidity for size, volatility and options

  • Effect is stronger for:
    • Small caps
    • High volatility
    • No options

What are the results on price discovery

A ban slows firm specific news --> the more autocorrelation the slower the news is incorporated in the prices

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