Short-Selling Equity Exchange Traded Funds and Its Effect on Stock Market Liquidity

Egle Karmaziene and Valeri Sokolovski

Journal of Financial and Quantitative Analysis, 2022, vol. 57, issue 3, 923-956

Abstract: We examine short selling of equity exchange traded funds (ETFs) using the 2008 short-sale ban. Contrasting the previously documented contractions in bearish strategies during the ban, we find a significant increase in short sales of the largest, most liquid ETF, the S&P 500 Spider. We offer evidence suggesting that this upsurge was driven primarily by investors circumventing the ban. We show that the ban’s detrimental effect on stock liquidity was around 30% less severe for the Spider’s constituents. Our results suggest that ETF shorts can substitute for short sales of individual stocks, thereby alleviating short-sale constraints’ adverse effect on liquidity.

Date: 2022
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