The Impact of Actual Market Wide Short Selling Restrictions and Liquidity Constraints During the Financial Crisis of 2008

Abstract

This paper aims to investigate if derivatives instruments act as a substitute for short sales during periods of restriction imposed on short selling in the cash market for stocks. Contrasting the trading activity in derivative instruments to the underlying stocks, we find no evidence of a transfer of short selling interests to the derivatives markets. In fact we find that trading volumes in derivatives are more negatively affected by the restrictions and the general liquidity crisis than for stocks where trading activity is actually increasing during the period. A larger proportion of price discovery is occurring in the cash market for stocks as opposed to futures during the crisis period, comparing 2008 to 2007.