A Tale of Two Markets: Understanding the 2008 Shorting Ban

Abstract

To understand any policy change, one must investigate the supply and demand forces that may affect the equilibrium outcome. However, there has yet to be an extensive study that isolate the supply and demand factors contributing to the degradation of market quality during the 2008 shorting ban. This study conducts time fixed-effects panel regressions and difference-in-difference tests to investigate the effects of the shorting ban on (1) institutional investors and short sellers in the stock lending market, and (2) market liquidity in the stock market. The main finding of this study is that the shorting ban is statistically significant in explaining the unexpected spikes in stock market lending fees during the 2008 financial crisis, but it is not significant in explaining the apparent decrease in the supply of loanable stocks. In addition, this study shows that the shorting ban only has significant impact on the rise in bid-ask spread which is a proxy for costs of transaction. Contrary to the results of the current set of academic literature which condemns the shorting ban for degrading market liquidity, the results of this study indicate that the shorting ban is actually not significant in explaining the rise of illiquidity as measured by price impact.