Predatory Short Sales and Bailouts

Sebastian Kranz, Gunter Löffler and Peter Posch

German Economic Review, 2019, vol. 20, issue 4, e469-e491

Abstract: This paper extends the literature on predatory short selling and bailouts through a joint analysis of the two. We consider a model with informed short sales, as well as uninformed predatory short sales, which can trigger the inefficient liquidation of a firm. We obtain several novel results: A government commitment to bail out insolvent firms with positive probability can increase welfare because it selectively deters predatory short selling without hampering desirable informed short sales. Contrasting a common view, bailouts can be optimal ex ante but undesirable ex post. Furthermore, bailouts in our model are a better policy tool than short selling restrictions. Welfare gains from the bailout policy are unevenly distributed: shareholders gain while taxpayers lose. Bailout taxes allow ex ante Pareto improvements.

Date: 2019
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https://doi.org/10.1111/geer.12173

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