PRICE INFLATION AND WEALTH TRANSFER DURING THE 2008 SEC SHORT-SALE BAN

Lawrence E. Harris, Ethan Namvar and Blake Phillips

We estimate that the ban on short-selling financial stocks imposed by the SEC in September 2008 led to price inflation of 10-12% in the banned stocks based on a factor-analytic model that extracts common valuation information from the prices of stocks that were not banned. This inflation reversed approximately two weeks after the ban for stocks with negative pre-ban performance. In contrast, similar magnitude price inflation was sustained following the ban for stocks with positive pre-ban performance, suggesting that the ban was successful in stabilizing prices for these stocks. Cross-sectional analysis reveals that inflation was isolated to stocks without traded options, suggesting that option markets provided a mechanism for traders to circumnavigate the ban. Further, we find that the level and change in short interest associated with the ban are unrelated to the level of inflation. These results suggest that price pressure associated with closing short positions at the start of the ban is unrelated to the noted price inflation. If prices were inflated, buyers paid more than they otherwise would have for the banned stocks during the period of the ban. We provide a conservative estimate of $2.3 to $4.9 billion for the resulting wealth transfer from buyers to sellers, depending on how post-ban reversal evidence is interpreted. Such transfers should interest policymakers concerned with maintaining fair markets.