The Price Effect of Temporary Short-selling Bans: Theory and Evidence

Abstract

We develop a model of temporary short-selling bans by extending the infinite-horizon speculative bubble model of Scheinkman and Xiong (2003). Our model predicts that a short-selling ban leads to a price inflation that is the highest at the beginning of the ban and gradually converges to zero at the end of the ban. Examining the 2008 short-selling ban of financial stocks in the U.S., we find evidence consistent with this prediction. The innovation of our empirical design is to use the financial segments of non-banned stocks as a control group for the banned financial stocks.