History, in the form of economic crises, does indeed repeat itself. But there are wide variations across the experiences of individual countries and across time, and the response of policy makers often determines the severity of the recessions that usually accompany financial crises of all types. This policy brief provides a brief history of short selling and its critics, and considers the question of whether a “herd-like mentality” exists during financial crises.

Policy makers have repeatedly reacted to financial crises by imposing restrictions on the ability of stock market participants to short sell equities, despite overwhelming evidence that these restrictions are in fact ineffective. This brief discusses what can be done to convince policy makers of the strength of the academic research that short-selling bans don’t have the desired effect.

What are the policy options? First, the “politics” of imposing short-selling restrictions should be removed as the initial policy option. Second, the policy should be that short-selling bans are to be introduced only as a last resort. Finally, coordination at a global level needs to be undertaken by fora such as the Financial Stability Board and the G20 when considering when, and what type of bans are to be permitted, given that global equity markets move more or less in tandem.   

Key Points

  • Short-selling bans invariably fail to accomplish their stated objectives to prevent price declines and distort equity market pricing.
  • Policy makers need to be clear and transparent about the economic arguments behind any desire to impose a ban on short selling.
  • Short-selling bans may be effective under certain circumstances, but only if policy makers around the world cooperate through fora such as the G20 and the Financial Stability Board.
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