Short-Selling Bans and Bank Stability
39 Pages Posted: 17 Feb 2016
Date Written: February 2016
In both the 2008-09 subprime crisis and the 2011-12 euro debt crisis, security regulators imposed bans on short sales, designed mainly with financial institutions in mind. The motivation was that a collapse in a bank's stock price could lead to funding problems, triggering further price drops: the ban on shorting bank stocks was supposed to break this loop, stabilizing banks and bolstering their solvency. We test this hypothesis against evidence from both crises, estimating panel data regressions for 13,473 stocks in 2008 and 16,424 stocks in 2011 in 25 countries, taking the endogeneity of short-selling bans into account. Contrary to the regulators' intentions, in neither crisis were the bans associated with increased bank stability. Instead, when financial institutions were subjected to a short-selling ban, they displayed larger share price drops, greater return volatility and higher probability of default. And the effects were more pronounced for the more vulnerable banks. Nor did the ban in 2011 do anything to mitigate the 'diabolic loop' between bank and sovereign insolvency risk during the euro-area sovereign debt crisis.
Keywords: ban, bank stability, financial crisis, short-selling, systemic risk
JEL Classification: G01, G12, G14, G18
Suggested Citation: Suggested Citation