As debates over short selling rage both in the United States and Europe, two new reports question the effectiveness of the short-selling bans enacted by a quartet of nations this summer.
Reports released on Monday by both Credit Suisse and Instinet found that the Aug. 12 short-selling bans on certain financial companies instituted by Belgium, France, Italy and Spain did little to slow the slide in share prices for affected stocks.
The Credit Suisse study found that since the effective date of the bans, which are still in effect and have now been extended, financial stocks for which shorting is banned are down 10.4 percent, while financials without a ban are down only 4.4 percent.
This implies that long sellers, not short sellers, are forcing prices down, according to the study. What is more, the bans on short selling seem to have reduced liquidity in the banned names.
Perhaps most disturbing, however, the study found that the bans might have contributed to the widening of bid-ask spreads. After the ban, the average spreads in affected financials diverged from non-affected financials that the study examined—the stocks with bans on shorting displayed relatively wider spreads.
“They tracked each other quite well in the build-up to the ban, and it’s only when the ban was introduced that you see the divergence,” said Mark Buchanan, a director of portfolio strategy at Credit Suisse and one of the co-authors of the report.
Buchanan noted the increase in the bid-ask spread would typically lead to higher costs of trading. Jonathan Tse, another co-author of the report, added that these costs could get passed along to investors trying to rebalance their portfolios or engage in other activities completely independent from the speculation targeted by the bans.
The Instinet study did not reach the same findings regarding bid-ask spreads. But it did find that financial stocks in countries with the ban have performed similarly to financials in countries without the ban.
The study did find that in Italy and Spain financial stocks fared somewhat better than the national blue chip indexes. In Belgium and France, however, financials performed more poorly than the overall market, in spite of the bans on short selling.
“During volatile periods, even in the presence of a short-sale ban, markets move where they’re going to move based on fundamental and macroeconomic factors,” said Alison Crosthwait, author of the report and managing director for global market structure research at Instinet. “A short-sale ban does not provide a cushion or floor to prices.”
Volatility, as measured by the degree of average daily price moves, fell during the period of the short-sale bans. But the study found the reduction in volatility in Belgium, France, Italy and Spain was similar to the reduction in other European countries as well as in the U.S. and Canada.
The study concluded that the short-sale bans did not succeed in protecting markets from extreme volatility—and if anything harmed market quality.
The two reports’ findings echoed those of previous studies that examined short-selling restrictions in Germany in 2010 and around the world in 2008. Some of those studies were able to use more data and longer time horizons, Crosthwait said.
Still, when markets are volatile, regulators are often tempted to take decisive actions, even if the evidence might question the effectiveness of those moves, she added.
“They are thinking very carefully, judiciously, about their decisions, but I don’t think that the academic studies are the major factor impacting their decisions,” Crosthwait said.
