Table of Contents


    During the financial crisis that started in 2008, at least 18 countries including the United States implemented restrictions on short selling. There was significant variation in how these restrictions were imposed and lifted at different dates, applied to different sets of securities, and featured different degrees of stringency. This variation makes it easier for economists to assess the impact of each action and tease out (or “isolate”) the impact of short selling restrictions from other factors. The same can be said for 2011, when multiple countries in the European Union implemented short-selling restrictions in response to the euro crisis. In analyzing the data from these periods, restrictions on short selling were found to reduce liquidity, slow price discovery, increase risk aversion, and generally failed to support stock prices.

    Short Selling Restrictions Reduce Liquidity

    During both the 2008 crisis and the euro crisis, liquidity deteriorated in the countries where short selling restrictions were imposed on markets. A principal measure of liquidity is the bid-ask spread for a particular security, as a wider spread connotes less liquidity. In 2008, the median bid-ask spread for securities subject to a restriction was 2.27 times as large as the pre-restriction value for the same security. Italy saw the worst impact on liquidity, and Denmark, Australia, and Norway were close behind. The United States, UK, and Ireland also experienced meaningful decreases in liquidity.

    Short Selling Impairs Price Discovery

    Economists finds that short selling restrictions slowed price discovery during the 2008 crisis and the euro crisis, as restrictions limited the ability of investors to react to new information. This phenomenon is particularly pronounced in times of downturn as investors with negative fundamental information are restrained from trading. By slowing the price discovery process, short selling restrictions are also likely to increase uncertainty. After the crisis, European policymakers established the European Regulation on Short Selling (SSR), which among other things required investors to disclose certain short positions. In studying the effects of this regulation, ESMA found that disclosure thresholds create risk of pricing inefficiencies as investors cluster right below the threshold out of reluctance to expose their strategy. ESMA also found that “investors react to public disclosure by increasing the size of their position, thereby reinforcing herd behavior.” 

    Announcement of Short Sale Restrictions is Associate with Heightened Risk Aversion

    During the euro crisis, investors’ risk aversion increased significantly immediately following the announcement of short selling restrictions. In addition, throughout the restriction period median volatility skews, which can be used as a metric for risk aversion, rose much more for restricted stocks than for unrestricted stocks. In periods of market turmoil, the negative signaling associated with restricting short selling, combined with a reduction in liquidity and price discovery, ultimately leaves the system worse off.

    • Beber, A. and Pagano, M. (2013), Short‐Selling Bans Around the World: Evidence from the 2007–09 Crisis
    • Felix, L., Kraeussl, R., and Stork, P. (2013), The 2011 European Short Sale Ban on Financial Stocks: A Cure or a Curse?. 
    • Short-Selling Bans and Bank Stability (2018), ESRB Working Paper Series No 64. 
    • ESMA’s Technical Advice on the Evaluation of Certain Elements of the Short Selling Regulation (2017).
    • ESMA’s Report on Trends, Risks, and Vulnerabilities (No. 1, 2018).