The Regulation of Short Sales and its Reform

Research output: Contribution to specialist publicationArticle

Abstract

Short selling has long been regarded as an extreme form of “casino capitalism” that destabilises financial markets, raising also concerns regarding their moral foundations. Hostility against short selling gathered unstoppable momentum in September 2008 in the middle of the market price collapse of financial sector stocks. Short sales were seen as the principal cause of those precipitous falls. As a result, most developed market regulators declared a ban on short sales in financial sector stocks.

However, a large number of empirical studies indicate that short sales are, in fact, a beneficial source of market efficiency. This view has been confirmed by studies on the September 2008 ban, which show that the prohibition did not yield any concrete benefits, especially in terms of reduction of price volatility.On the contrary, it had an adverse impact on liquidity. The market abuse rationale, offered as the main justification for the September 2008 ban, was also unconvincing. Furthermore, US and European regulatory orders banning short sales revealed how disparate are the regimes governing cross-border securities trading.

This article argues that the best way to regulate short sales is through a dual strategy of disclosure and short trading halts, rather than a prohibition or an uptick rule. The short trading halts should be based on a sophisticated circuit breaker system that is focused on short and medium term market conditions and preserves the proper function of the price formation mechanism. Disclosure and short trading halts should be complemented by a strict settlement regime, which would eliminate the scope for aggressive speculation through uncovered positions.
Original languageEnglish
Pages24-27
Number of pages4
Volume8
No.1
Specialist publicationCESifo DICE Report
Publication statusPublished - 2010

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