Several recent studies have indicated that the ban on short selling some stocks implemented last fall had a negligible, if not a negative, impact on markets.  Not only did the bans fail to halt the downward slide in stock markets, but they also led to an increase in bid-ask spreads – a sure sign that market liquidity (and thus efficiency) declined.

But one of the ongoing challenges these studies have faced was to determine how much of the post-ban slide in markets was the result of the continuing (and even accelerating) market mayhem and how much might have actually been caused by the bans themselves.  In fact, a new analysis by Abraham Lioui of French research centre Edhec-Risk says that these studies “are unable to disentangle the impact of the ongoing crisis in the financial markets from the impact of the ban on short selling.”

Lioui proposes another approach to “disentangling” the effects of the financial crisis and the effects of the short-bans themselves.  They come to the “odd” conclusion (their description) that equity indices seem to have responded more “strongly and systematically” to the short bans than did the so-called “off-limits” stocks themselves (those where shorting was actually banned).

We summarize Lioui’s conclusion below: More…