Short Sale Bans May Improve Market Quality During Crises: New Evidence from the 2020 Covid Crash

Caroline Fohlin, Zhikun Lu and Nan Zhou

No 17725, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: In theory, banning short selling stabilizes stock prices but undermines pricing efficiency and has ambiguous impacts on market liquidity. Empirical studies find mixed and conflicting results. This paper leverages cross-country policy variation during the 2020 Covid crisis to assess differential impacts of bans on stock liquidity, prices, and volatility. Results suggest that bans improved liquidity and stabilized prices for illiquid stocks but temporarily diminished liquidity for highly liquid stocks. The findings support theories in which short sale bans may improve liquidity by selectively filtering out informed—potentially predatory—traders. Thus, policies that target the most illiquid stocks may deliver better overall market quality than uniform short sale bans imposed on all stocks.

Keywords: Covid-19 pandemic; Financial market microstructure; Liquidity (search for similar items in EconPapers)
JEL-codes: G01 G12 G14 G18 (search for similar items in EconPapers)
Date: 2022-12
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