'Shooting the Messenger?' The Impact of Short Sale Bans in Times of Crisis

Abstract

We find that the bans on covered short sales, implemented in several countries during the financial crisis of 2008-09 improved market liquidity or at least had a neutral impact; a result we argue could be expected in theory, given a simple variation on the Diamond-Verrechia (1987) model. The result holds for daily data over an extended period as well as for intraday data over various time spans. In contrast to other recent studies, we use American Depository Receipts as the controls in a difference-in-difference analysis encompassing all banned non-U.S. shares with corresponding depository receipts listed in the United States. Furthermore, we find that bans on covered short sales generally succeeded in lowering volatility. Banning short selling is not good policy in normal times, but our findings indicate that such bans might prove useful in (temporarily) stemming liquidity loss during crises.

Keywords: short selling ban, liquidity, volatility

JEL Classification: G14, G18