Short-selling doesn't affect stock prices, research reveals

Academic research from Professor Ian Marsh and Norman Niemer of Cass Business School, London has found no strong evidence that the emergency short selling restrictions imposed in various markets around the world have changed the behaviour of stock returns.

The researchers examined daily returns on UK, US, Italian, French and German shares before and after the introduction of restrictions on short-selling, including shares which are subject to the restrictions, and those which are not.
 
The research found no strong evidence that restrictions on short selling changed the behaviour of stock returns.

Stocks subject to the restrictions behaved very similarly both to how they behaved before their imposition and to how stocks not subject to the restrictions behaved.

Comparing behaviour across countries where the nature of the restrictions differed, the authors found no systematic patterns consistent with the expected effect of the new regulations, i.e. no evidence of a reduced probability of large price falls.

The authors also found no sign of any detrimental impact of the constraints in terms of reduced efficiency of pricing.

Regression analysis suggested that changes in stock returns were driven mainly by other factors affecting the financial sector as a whole rather than the restrictions on short-selling. That is, some systematic changes in the behaviour of financial sector stocks could be discerned, but no strong evidence of a systematic impact of the restrictions could be identified.

The International Securities Lending Association, the Alternative Investment Management Association and the London Investment Banking Association jointly commissioned the research.

In a joint statement, the associations said they: "Continue to offer their full support to all efforts in identifying appropriate and reasonable measures for the longer-term security and stability of the financial system.

"On the basis of this research, the associations see no case for continued bans on short selling as there is no strong evidence that these have been effective in reducing share price volatility or limiting share price falls."

Research from Australian hedge fund manager Platypus Capital Management has also reached similar conclusions but over a much longer time frame.

Platypus, a quantitative firm with two small long/short hedge funds, examined Dow Jones Industrial Average stock price and short selling data from 1999 to 2008, as well as at the New York Stock Exchange Composite Index and NYSE's short selling data from 1995 to 2008.

In neither case could the researchers find any statistically significant relationship between increases in short selling and changes in stock prices - nor indeed any link between short-selling and stock price volatility.

The study looked at monthly changes in short selling, as measured by changes in the ratio of short positions to average trading volume, and compared these with monthly changes in stock prices for Dow stocks in the same month as well as with price changes one, two, three and six months later.

The authors repeated the exercise for the NYSE Composite Index. In both cases they looked for a meaningful statistical relationship between changes in short-selling and changes in share prices, on the one hand, and between changes in short-selling and volatility, on the other, but no such relationships emerged from the data.

Platypus partner Derek Sicklen says: "It looks like the dramatic sell-off in global equity markets has been driven by institutional and retail holders of stocks heading for the exits, rather than by the actions of speculators shorting stocks. This is probably not a popular conclusion, but it seems to accord with the data.

"But the real problem is that regulatory restrictions on short selling are causing significant redemptions from long/short hedge funds. As most such funds have a long bias, this means that these funds are liquidating mainly long positions en masse to meet redemptions.

"This can only be bad news for equity prices, and a textbook example of the law of unintended consequences where restrictions on short selling can actually increase sales of equities."