SHORT-SELLING BAN EXACERBATED CRISIS, ACCORDING TO EUROPEAN RESEARCH STUDY

Posted April 16, 2009

NICE, France -- An in-depth study of short-selling activities by EDHEC (École De Hautes Études Commerciales du Nord) Finance Professor Abraham Lioui, entitled “The Undesirable Effects of Banning Short Sales,” calls into question both the reasons for the decision to ban short selling and the prejudices that weigh on those who short.

Among the consequences of the ban that are noted in the EDHEC position paper:

• Market volatility rose sharply because there was no clarity on the reasons behind the measure.

• The impact of the ban on market volatility was greater than the impact of the financial crisis.

• Share prices deviated yet more from their fundamental value.

• The risk/return possibilities of investors worsened.

• The desired effect on market trends has not been achieved (no reduction of the negative skewness of returns is being observed) and there is no evidence of the possible impact of this measure on extreme market movements.

According to recently published data (for the US in particular), a large majority of short sellers are market makers who are hedging their bets on the options markets. They were not affected by the ban, which means that those who were using options to take synthetic short positions continued to do so. The others involved in short selling are mainly hedge funds. The average return over the last ten years for hedge funds that used short-sale, convertible arbitrage and long/ short strategies was 3 percent, 4.75 percent and 7 percent respectively. One can hardly argue that they were over-informed and that they earned abnormal returns.

In brief, short sellers perhaps did not really merit the punishment that, by simply banning the shorting of the shares of financial institutions, the market authorities recently meted out. The EDHEC study confirms that the shares that were the object of the ban were relatively unaffected by it.

A copy of “The Undesirable Effects of Banning Short Sales” can be downloaded here: http://docs.edhec-risk.com/mrk/000000/Press/EDHEC_Undesirable_Effects_Short_Sales_Ban.pdf