Short-Selling Bans and Bank Stability

Abstract

In both the subprime crisis and the eurozone crisis, regulators imposed bans on short sales mainly aimed at preventing stock price turbulence from destabilizing financial institutions. Contrary to the regulators’ intentions, financial institutions whose stocks were banned experienced greater increases in the probability of default and volatility than unbanned ones. Increases were larger for more vulnerable financial institutions. To take into account the endogeneity of short sales bans, we match banned financial institutions with unbanned ones with similar sizes and levels of riskiness and instrument the 2011 ban decisions with regulators’ propensity to impose a ban in the 2008 crisis.

Short-selling restrictions and financial stability in Europe: Evidence from the Covid-19 crisis

“…We provide robust evidence that imposing short-selling bans during the Covid-19 crisis had negative effects on market quality, especially for smaller markets and smaller stocks. These findings are consistent with previous research on the negative effects of short-selling bans during the 2008/2009 global financial crisis ( Beber and Pagano, 2013 , Boehmer et al, 2013 ) and 2011/2012 European sovereign debt crisis ( Beber et al, 2021 ). In additional analyses, we observe that countries with a weaker state of the economy, lower fiscal capacity, lower financial development, and stricter lockdown measures were more likely to restrict short selling.…”

“…However, the empirical evidence of this study supports the decision of those countries that refrained from implementing short-selling restrictions despite ample political pressure to do the opposite. This perspective is consistent with the conclusions of Beber and Pagano, 2013 , Beber et al, 2021 , Pagano, 2020 . Interestingly, no country imposed a ban during the later Covid-19 waves, which were much more severe and detrimental for the economy, indicating that markets can function well during crisis periods even without regulatory interventions.…”

“…Moreover, our findings do not support the “Overvaluation”-Hypotheses of Miller (1977) , which predicts that short-selling bans positively bias fundamental values leading to higher stock prices temporarily during the restrictions. Nevertheless, the previous empirical evidence is rather inconclusive, as there is more ( Boulton and Braga-Alves, 2010 , Frino et al, 2011 , Beber and Pagano, 2013 ) or less support for Miller’s theory ( Beber et al, 2021 , Boehmer et al, 2013 ). However, the theory may not be fully applicable to this situation, as the ban also affected the trading environment and market quality, which we need to consider as well.…”

Investor behavior around targeted liquidity announcements

“…For this reason, during the financial crisis many stock exchange regulators implemented short-sales bans to mitigate its impact on bank stocks. However, such bans often have unintended consequences, such as lower market liquidity and slower price discovery (Beber et al, 2021), and they can also lead to a higher probability of default and volatility for bank stocks (Beber & Pagano, 2013). For this reason, we analyze the potential effect of TLTRO announcements on short sales because, unlike outright short-sales bans, they can improve bank value without necessarily impairing market liquidity or increasing the volatility of bank stock prices.…”

“…Third, our paper speaks to the literature on short selling of bank stocks (Beber et al, 2021;Beber & Pagano, 2013), and the connection between funding and market liquidity (Brunnermeier & Pedersen, 2009). Unlike these studies, we examine net short positions on bank and non-bank stocks around the TLTRO announcements to test the theoretical predictions of Liu (2015).…”