An in-depth study of short-selling activities, “The Undesirable Effects of Banning Short Sales,” calls into question both the reasons for the decision to ban short selling and the prejudices that weigh on those who short.

Among the consequences of the ban that are noted in the position paper:

-- Market volatility rose sharply because there was no clarity on the reasons behind the measure.

-- The impact of the ban on market volatility was greater than the impact of the financial crisis.

-- Share prices deviated yet more from their fundamental value.

-- The risk/return possibilities of investors worsened.

-- The desired effect on market trends has not been achieved—no reduction of the negative skewness of returns is being observed—and there is no evidence of the possible impact of this measure on extreme market movements.

According to recently published data, for the United States in particular, a large majority of short sellers are market-makers who are hedging their bets on the options markets. They were not affected by the ban, which means that those who were using options to take synthetic short positions continued to do so.

The others involved in short selling are mainly hedge funds. The average return over the last 10 years for hedge funds that used short-sale, convertible arbitrage and long/short strategies was 3%, 4.75% and 7%, respectively.

One can hardly argue that they were over-informed and that they earned abnormal returns.

In brief, short sellers perhaps did not really merit the punishment that, by simply banning the shorting of the shares of financial institutions, the market authorities recently meted out.

The study confirms that the shares that were the object of the ban were relatively unaffected by it.

--Dr. Abraham Lioui, EDHEC

The full report: A copy of the full, 36-page report, “The Undesirable Effects of Banning Short Sales” is available at

http://docs.edhec-risk.com/mrk/000000/Press/EDHEC_Undesirable_Effects_Short_Sales_Ban.pdf. Click through for the full report.

About the author: Abraham Lioui is professor of finance for the EDHEC Risk and Asset Management Research Centre. He can be reached at research@edhec-risk.com.

About EDHEC: EDHEC Business School, founded in 1906 and holding the triple crown of EQUIS, AACSB and AMBA accreditations, has campuses in Lille, Nice and Paris, France, and hosts some 5,000 students, more than 25% of whom are from abroad, and 110 full-time faculty members. It is recognized as a center of excellence for asset management and alternative investment research, including asset management, fixed-income securities, alternative investments and risk management.