Alessandro Beber and Marco Pagano
Short-selling bans around the world: lessons from the financial crisis
Journal of Finance | Volume 68, Issue 1 (Feb 2013), 343–381

On 19 September 2008—just as the failure of Lehman Brothers had shaken investors' confidence in banks' solvency and sent stocks into free fall—the U.S. Securities and Exchange Commission (SEC) prohibited “short sales” of financial companies' stocks. The hope was that this would stem the tide of sales and help support bank stock prices.

The SEC's move sparked worldwide herding by regulators. In the subsequent weeks and months, most stock exchange regulators around the globe issued bans or regulatory constraints on short selling. Some of the bans were “naked,” i.e. only ruled out sales where the seller does not borrow the stock in time to deliver it to the buyer within the standard settlement period (naked short sales). Other bans were “covered,” ruling out also sales where the seller manages to borrow the stock (covered short sales). By the end of October 2008, no less than 20 countries around the globe had imposed some form of short-selling ban.

These hurried interventions, which varied considerably in intensity, scope and duration, were invariably presented as measures to restore the orderly functioning of security markets and limit unwarranted drops in securities prices. Did they achieve their stated purpose? And did they have any negative side effects?

Both theoretical arguments and previous evidence would have advised greater caution. The effectiveness of short-selling bans in supporting stock prices is controversial, and several previous studies alerted that such bans can damage stock market liquidity and slow down the speed at which new information is impounded in stock prices. Because the crisis was accompanied by a widespread and steep increase in bid-ask spreads in stock markets, it is important to understand whether, and to what extent, short-selling bans contributed to their increase, and therefore reduced stock market liquidity.

Was the SEC right?

Now that economists have canvassed the evidence about the short-selling bans during the crisis, it is possible to evaluate this policy intervention. Boehmer-Jones-Zhang (WP 2009) have analyzed the response of liquidity measures to the short-selling ban imposed by the SEC from September 19 to October 8, exploiting the difference between the financial sector stocks targeted by the ban and those that were not. They have found that liquidity—as measured by spreads and price impacts—deteriorated significantly for stocks subject to the ban.

But did the SEC at least manage to achieve its stated objective, that is, stem the collapse of stock prices? Even this is unclear. Boehmer-Jones-Zhang (WP 2009) document large price increases for banned stocks upon announcement of the ban, followed by gradual decreases during the ban period. Yet they recognize that the correlation with the ban could be spurious, as the prices of U.S. financial stocks could have been affected by the accompanying announcement of the U.S. bank bail-out program—the Troubled Asset Relief Program (TARP). Their skepticism is reinforced by the finding that stocks that were later added to the ban list experienced no positive share price effects. However, Harris-Namvar-Phillips (WP 2009) try to control for the TARP legislation and find that the positive abnormal returns for banned stocks cannot be explained by a TARP fund index.

Clearly, reliance on data from the U.S.—where the start of the short-selling ban on financials coincided with bank bailout announcements—makes it hard to identify the price effects of the ban. International evidence can be valuable in this respect, because short-selling bans in several other countries were not accompanied by bank bailout announcements. Moreover, in many countries bans also applied to non-financial stocks, and in other countries financial stocks were simply not banned.

New worldwide evidence

In Beber-Pagano (JF 2013), we harness the large amount of evidence that short-selling bans generated during the crisis, assembling daily data for nearly 17,000 stocks from 30 countries, for the period spanning from January 2008 to June 2009. A key feature of the data is that short-selling restrictions were imposed and lifted at different dates in different countries. They often applied to different sets of stocks (only financials in some countries, all stocks in others) and featured different degrees of stringency. This variation in short-selling regimes is important because it makes the data ideally suited to identify the effects of the bans through panel data techniques. The extent of variation in short-selling regimes between September 2008 and June 2009 is illustrated in Figure 1 via color-coded lines. Dark and light blue lines correspond to naked bans of financial and non-financial stocks, respectively. Red lines indicate covered bans for financial stocks, while orange lines correspond to covered bans of non-financial stocks. The figure illustrates the variety of regimes and regime durations across countries, as well as the complex regime variation over time, even within the same country (the extreme example here being Italy).

1: Short-selling ban regimes around the world, Sep08 To Jun09
A visual comparison across different countries.

In our empirical analysis we study whether stocks that were subject to short-selling restrictions featured different price performance, liquidity or informational efficiency when benchmarked against stocks exempt from such restrictions. In performing this comparison, we control for time-invariant stock characteristics, as well as for return volatility and for common risk factors. The latter controls are important, because during the crisis increased uncertainty and acute funding problems were likely to have affected stock market liquidity throughout the world.

2: Cumulative abnormal returns in the U.S. for stocks subject to covered bans and for exempt stocks
The figure plots cumulative abnormal returns in the 14 trading days after the ban date, which is date 0 in the graph.

Our results indicate that the bans have not been associated with better stock price performance, the U.S. being the exception. The most immediate evidence on this point is obtained by comparing post-ban median cumulative excess returns—with respect to market indices—for stocks subject to bans with those of exempt stocks. Figure 2 shows that the median cumulative excess return of U.S. financial stocks, which were subjected to a covered ban, exceeded that of exempt stocks throughout the 14 trading days after the ban inception (date 0 in the figure), a finding that agrees with that reported by Boehmer-Jones-Zhang (WP 2009). But Figure 3 shows that this is not the case for the other countries in our sample: the line corresponding to the median excess return on stocks subject to naked and covered bans is very close to that for exempt stocks, and it lies above it only in about half of the first 60 days of trading after the inception of the ban. Because the confounding factor of simultaneous policy measures is likely to convey a more accurate picture of the effects of short-selling bans on stock returns than the evidence for the U.S. shown in Figure 2.

3: Cumulative abnormal returns in countries with partial bans (except the U.S.) for stocks subject to ban and exempt stocks
The figure plots cumulative abnormal returns in the 60 trading days after the ban date, which is date 0 in the graph.

This conclusion is confirmed and actually reinforced by the econometric analysis. When we use our entire data set, bans on covered short sales turn out to be correlated with significantly lower excess returns relative to stocks unaffected by the ban, while bans on naked sales and disclosure obligation do not have a significant correlation with excess returns. When we consider countries with short-selling bans on financials only, bans turn out to be correlated with positive excess returns only for the U.S., not for other countries. But, as noted above, the positive correlation for the US may be spurious.

Hence, in contrast to the regulators' hopes, worldwide evidence indicates that short-selling bans have at best left stock prices unaffected, and at worst may have contributed to their decline.

Moreover, we find that short-selling bans imposed during the crisis had unintended but important negative consequences on liquidity and price discovery. Our results indicate that the bans are associated with a statistically and economically significant increase in bid-ask spreads throughout the world. In contrast, the obligation to disclose short sales is associated with a significant decrease in bid-ask spreads.

4: Average bid-ask spread of stocks subject to bans and of matched exempt stocks for countries with partial bans.
The lines plots the three-day moving average of the bid-ask spread's cross-sectional average for stocks subject to bans and control stocks (left scale) and their differential (right scale), in a 50-day window around the ban inception date (date 0). The data correspond to countries with partial bans: Belgium, Canada, Germany, Denmark, France, the Netherlands, Ireland, Norway, Austria, Portugal, the U.K., and the U.S.

In Figure 4 we plot the average bid-ask spreads of stocks subject to the ban and their matching stocks during our event window, as well as that of their differential. The matching stock is the exempt stock traded in the same country and with the same option listing status that is closest in terms of market capitalization and stock price level. The figure shows that immediately after the ban date the gap between the average bid-ask spread of banned stocks and that of exempt stocks widens, suggesting that the ban had a detrimental effect on liquidity. This conclusion is again confirmed by the econometric analysis.

We also find evidence that short-selling bans made stock returns more correlated with their own past values, that is, slowed down the reaction of stock prices to new information. This slowdown in price discovery especially when negative news are concerned, is in line with the findings of previous empirical studies, for instance Bris-Goetzmann-Zhu (JF 2007), and with the predictions of the theory. By restraining the trading activity of informed traders with negative information about fundamentals, a short-selling ban slows down the speed at which news are impounded in market prices, and more so in bear market phases.

Lesson learned?

To sum up, the evidence suggests that the knee-jerk reaction of most stock exchange regulators to the financial crisis—imposing bans or regulatory constraints on short-selling—was at best neutral in its effects on stock prices. The impact on market liquidity was clearly detrimental. Moreover, the bans were associated with slower price discovery.

Perhaps the main social payoff of this worldwide policy experiment has been that of generating a large amount of evidence about the effects of short-selling bans. The conclusion suggested by this evidence is best summarized by the words of the former SEC Chairman Christopher Cox on 31 December 2008: “Knowing what we know now, [we] would not do it again. The costs appear to outweigh the benefits.” Unfortunately, in sharp contrast with this assessment and with our strong evidence, security market regulators in some European countries have reacted to the more recent crisis events by imposing again short-selling bans on financial stocks. Apparently the lesson was not learned, at least by some regulators.

Titian (1488–1576): Diana and Castillo. Italy, 1559.. In 2008, the Duke of Sutherland announced that he would be willing to sell two Titian masterpieces (the other being Diana and Actaeon, shown after the next article) much below market value—for about $150m, half its estimated true value—to the UK National Art Galleries. After they declined, he decided to auction them off. After frantic fund-raising and much criticism for government funding in hard economic times, the UK finally managed to buy the paintings, after all. The United Kingdom thus barely avoided to what would have been the equivalent of Michelangelo's David leaving Italy. But...wasn't Tiziano Italian, anyway?