Market Declines: What is Accomplished by Banning Short-Selling?

Abstract

In 2008, U.S. regulators banned the short-selling of financial stocks, fearing that the practice was helping to drive the steep drop in stock prices during the crisis. However, a new look at the effects of such restrictions challenges the notion that short sales exacerbate market downturns in this way. The 2008 ban on short sales failed to slow the decline in the price of financial stocks; in fact, prices fell markedly over the two weeks in which the ban was in effect and stabilized once it was lifted. Similarly, following the downgrade of the U.S. sovereign credit rating in 2011 — another notable period of market stress — stocks subject to short-selling restrictions performed worse than stocks free of such restraints.

Keywords: short selling, down grade

JEL Classification: G12, G14, G18, G01