How the Australian Ban on Short Selling During the GFC Affected Market Quality and Volatility

Abstract

We examine the effects of the short selling ban, imposed by Australian regulators in the wake of the global financial crisis, on trading of financial stocks. Unlike other developed markets, where regulators imposed short-selling restrictions for brief periods of time at the height of the financial crisis, the ban on short selling of financial stocks on the Australian Stock Exchange lasted eight months, including both the tumultuous end of 2008 and the calmer period up to May 2009. Our control group consists of matched Canadian financial institutions which were unaffected by a short selling ban. We analyze the impact of the imposed short selling constraints on measures of market quality and on stock prices using univariate and multivariate fixed effects panel regressions. As predicted by previous theoretical work, we find that stocks subject to the short selling ban suffered a severe degradation in market quality. Controlling for the adverse effects of the financial crisis on financial markets, we show that imposing constraints on short-selling reduced trading activity, increased bid and ask spreads and increased intraday volatility. Moreover, there appears to be no evidence for lasting price support from the restrictions.