Do Short-Selling Regulations Matter? Evidence from Europe

Abstract

The Lehman Brothers bankruptcy on September 15, 2008 led to turmoil in financial markets, sharp declines in the stock prices of financial institutions, and fears for the stability of the global financial system. This prompted financial regulatory authorities in many countries to enforce bans on the short-selling of stocks, mainly of financial institutions. The aim of the short-selling bans was to halt further stock price declines and restore the confidence in the financial system. This study examines the impact of the 2008 short-selling regulations on (i) market liquidity, (ii) the components of the bid/ask spread, (iii) the speed of price adjustment to new information, and (iv) the spot-futures informational dynamics in Europe over the period January 2008–December 2009. The main purpose of this study is to provide new empirical evidence on the consequences of the short-selling measures in order to assist financial authorities to design more efficient and effective short-selling policies in the future. Overall, the results show that (i) liquidity deteriorates, (ii) both informational and non-informational components of the bid/ask spread increase, and (iii) the speed of information transmission is faster for the European financial stocks subject to total (naked and covered) short-selling bans with listed derivatives. In contrast, there is no evidence that short-selling bans affected the informational linkage between the spot and futures markets in Europe at the Banks super-sector level.