Financial crisis and short selling: do regulatory bans really work? Evidence from the Italian market

The global financial crisis and its effect on stock market volatility seems to have convinced market regulators of the extent of the destabilizing effect of short-selling and how it contributes to the undermining of the market’s confidence. Following the decisions of other market regulators, the Italian Securities and Exchange commission (Consob) decided to prohibit short-selling for domestic trading since the 23rd of September 2008, recognizing the greater severity for operations where banks and insurance company stocks are being sold short. The aim of this paper is investigate the impact on volatility and performance for stocks subject to these restrictions. By analyzing the effect on daily price returns and volatility following the addition of short-selling constraints and by using some control procedure able to isolate them from possible crisis induced movements, we do not find a impact of the restrictions for all the stocks. Whereas the results on the performance change show some differences in the trend of mean performance before and after the short-selling constraint that are particularly relevant for stocks without traded options, the results concerning the volatility impact show a general increase of the post-restriction variance, most of which can be attributed to the bans on shortselling. This finding appears contrary to the basic belief of market regulators that the shortselling ban is a useful tool that can mitigate volatility and speculative behaviors; new restrictions on short sellers are likely to reduce the amount of information incorporated into stock prices.