Efficiency and the Bear: Short Sales and Markets Around the World

Abstract

We analyze cross-sectional and time series information from forty-six equity markets around the world, to consider whether short sales restrictions affect the efficiency of the market, and the distributional characteristics of returns to individual stock and market indices. We construct two measures of price efficiency that quantify the asymmetric response of individual stock returns to negative vs. positive information, and find that prices incorporate information faster in countries where short sales are allowed and practiced. This evidence is consistent with more efficient price discovery at the individual security level. A common conjecture by regulators is that short sales restrictions can reduce the relative severity of a market panic. We test this conjecture by examining the skewness of market returns. We find some evidence that in markets where short selling is either prohibited or not practices, market returns display significantly less negative skewness. However, at the individual stock level, short sales restrictions appear to make no difference.

JEL Classification: F36, G15, G28