Short Selling Equity Exchange Traded Funds and its Effect on Stock Market Liquidity

54 Pages Posted: 22 Jan 2017 Last revised: 9 Jan 2019

See all articles by Egle Karmaziene

Egle Karmaziene

University of Groningen; Swedish House of Finance

Valeri Sokolovski

HEC Montreal - Department of Finance

Date Written: January 7, 2018

Abstract

We examine short selling of equity exchange traded funds (ETFs) using the September 2008 short-sale ban. Contrasting the previously-documented contractions in other bearish strategies, we demonstrate that during the ban the short sales of the largest and the most liquid ETF, the S&P 500 Spider, significantly increased. We offer evidence that it was driven primarily by short sellers circumnavigating the ban. We also document a concurrent increase in the supply of ETF shares suggesting that they can be created to accommodate short-sales. Additionally, we show that the detrimental effect of regulatory short-sale constraints on stock liquidity was up to 10% less severe for the constituents of the Spider. Our results suggest that short-sales of ETFs are a viable substitute for directional short-sales of individual stocks. They also highlight a novel channel through which ETFs can have a positive effect on the liquidity of its underlying securities.

Keywords: exchange traded funds, ETFs, short selling, ban, short-sale constraints, SEC, financial crisis, regulatory arbitrage

JEL Classification: G14, G18, G28

Suggested Citation

Karmaziene, Egle and Sokolovski, Valeri, Short Selling Equity Exchange Traded Funds and its Effect on Stock Market Liquidity (January 7, 2018). Swedish House of Finance Research Paper No. 14-05. Available at SSRN: https://ssrn.com/abstract=2901916 or http://dx.doi.org/10.2139/ssrn.2901916

Egle Karmaziene (Contact Author)

University of Groningen ( email )

P.O. Box 800
9700 AH Groningen, Groningen 9700 AV
Netherlands

HOME PAGE: http://sites.google.com/site/eglekarmaziene/

Swedish House of Finance

Drottninggatan 98
Stockholm, 111 60
Sweden

Valeri Sokolovski

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada

HOME PAGE: http://www.hec.ca/en/profs/valeri.sokolovski.html

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