Short Selling Equity Exchange Traded Funds and its Effect on Stock Market Liquidity
54 Pages Posted: 22 Jan 2017 Last revised: 9 Jan 2019
Date Written: January 7, 2018
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: Suggested Citation