Short-Sale Regulation:
Myths and Facts
S. Ghon Rhee
K. J. Luke Distinguished Professor of Finance
Executive Director
Asia-Pacific Financial Markets Research Center
University of Hawai‘i
For Presentation at the 5th OECD/ADBI Round Table
“Capital Market Reforms in Asia”
November 19-20, 2003, Tokyo, Japan
FIMA Research Center,
University of Hawai'i
1
Current Status of Short-Sale
Regulation in Asia
Country
Short-Selling
Permitted
China
Hong Kong, SAR
No
Yes
Indonesia
Yes
Japan
Yes
Korea
Malaysia
Philippines
No
No
No
Singapore
No
Taipei,China
Thailand
No
Yes
Details
Allowed for Designated Securities
Reinstated Uptick Rule in 9/98
No Specific Regulations Prohibiting
Short Selling as long as Sufficient
Shares are Available
Uptick Rule
Last Price is a Downtick or a ZeroMinus Tick as of 3/6/02
SEC Approved the Rules on SBL and
Short Selling, but they are not
clearly defined
No statutory prohibition, but the
present CDP system actively works
against it.
Allowed for the SET 50 Component
Stocks
Source: Morgan Stanley
FIMA Research Center,
University of Hawai'i
2
Recent Developments in
Short-Sale Regulation:
US Market
SEC Concept Release No. 34-42037: Short
Sale (September 1999)
Two Focuses:
a. Potential Abuse of Short-Selling for Downward Price
Manipulation on Illiquid Stocks
b. Application of the Up-Tick Rule to all US Markets
Currently Nasdaq Small Cap, OTC Bulletin Board,
and OTC Pink Sheet are not subject to short sale
restrictions
FIMA Research Center,
University of Hawai'i
3
Recent Developments in
Short-Sale Regulation:
UK Market
FSA Discussion Paper 17 “Short Selling”
(October 2002)
FSA Position
a.
Short Selling is a legitimate investment
activity
b.
Introduction of Specific Regulatory
Constraints Not Warranted
c.
Greater Transparency
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University of Hawai'i
4
Recent Developments in
Short-Sale Regulation:
Japanese Market
FSA’s Anti-Deflationary Measures (February 2002)
a.
b.
c.
d.
e.
Up-Tick Rule (as of March 2002)
Review of Margin Transactions and Institutional
Borrowing
Increase in lending rate of individual stocks identified
for excessive borrowing
Disclosure of Short-Selling Data on a regular Interval
Revision of Stock Exchange Rules for Additional
Collateral for Margin Transactions
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University of Hawai'i
5
What Do We Know About the
Impact of Short-Sales
Constraints?
1. Do They Impede Market Efficiency?
2. Do They Prevent Price Declines?
3. Do They Cause Overpricing and
Subsequent Negative Returns?
4. Do Speculative Short Sales Exist?
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University of Hawai'i
6
Do Short-Sale Constraints
Impede Market Efficiency? (I)
The Answer is Positive
US Market:
Aggregate level of short sales for individual
stocks is disseminated only once a month
Australian Market:
Short sale-related information is
disseminated on real time basis
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University of Hawai'i
7
Do Short-Sale Constraints
Impede Market Efficiency? (II)
Significant Negative Reaction to Short Sale
Information is Found
Negative returns are approximately -0.02%
over 20 trades after short-sales information is
released [Aitken, Frino, McCorry, and Swan (1998)]
High degree of transparency is desired since
short sales convey the information that results
in reassessment of stock valuation
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University of Hawai'i
8
Do Short-Sale Constraints
Impede Market Efficiency? (III)
Hong Kong Market

Before January 3, 1994:
No short selling was allowed in Hong
Kong
b. As of March 25, 1996:
113 stocks were allowed to be sold
short and HKEx abolished the uptick
rule
FIMA Research Center,
University of Hawai'i
9
Do Short-Sale Constraints
Impede Market Efficiency? (IV)
Relation between the Hang Seng Index futures market and
the underlying HIS component stock market strengthens
with the introduction of short sales
a.
Contemporaneous Correlation
0.077
Before January 1994
0.249
After March 25, 1996
b.
Duration of the HIS Futures market lead over
the HIS cash market
15 minutes Before January 1994
9 minutes After March 25, 1996
Jiang, Fung, and Cheng (2001)
FIMA Research Center,
University of Hawai'i
10
Can Short-Sales Constraints
Prevent Price Declines?
The Answer is Negative
a.
b.
c.
If some investors are constrained from selling short,
their unrevealed negative information will not be
manifest until the market begins to drop, which further
aggravates market declines [Hong and Stein (2002)]
Price reactions to quarterly earnings announcements
are greater when short-sales are costly [Reed (2003)]
Distribution of earnings announcement-day returns is
more left-skewed and suffer from higher volatility
when short-sales are costly [Reed (2003), Ho (1996)]
FIMA Research Center,
University of Hawai'i
11
Do They Cause Overpricing and
Subsequent Negative Returns?
The Answer is Positive
a. With short-sales constraints, a stock
price will reflect the optimists’ valuations
because the pessimists simply sit out of
the market as opposed to selling short.
b. Stocks that are expensive to short tend
to be overpriced and exhibit low
subsequent returns
FIMA Research Center,
University of Hawai'i
12
Nikkei 225 Index Movement and
Short-sale Regulation
15000
14000
3/6/02
11358.53
13000
12000
11000
9/5/02
9222.12
10000
2/8/02
9686.06
3/19/03
8051.04
11/4/02
9/4/02
7/4/02
5/4/02
3/4/02
1/4/02
11/4/01
FIMA Research Center,
University of Hawai'i
9/4/01
7/4/01
5/4/01
3/4/01
1/4/01
7000
3/4/03
8000
1/4/03
9000
13
Do Speculative Short Sales
Exist? (I)
Perhaps Yes in the Past but No Longer
Day-of-the-Week Anomaly in the US Market
(1962-1999)
a.
Large Positive Returns on Fridays:
0.245%
b.
Large Negative Returns on Mondays:
.
-0.093%
Total Week-end Effect
0.338%
The inability of trading over the weekend forces short
sellers close speculative short positions on Fridays and recreate the position on Mondays
FIMA Research Center,
University of Hawai'i
14
Do Speculative Short Sales
Exist? (II)
A. Week-End Returns
Stocks with high short interest vs. Stocks with
low short interest:
0.39% vs. 0.27%
B. Subperiod Week-End Returns
(Individual Stock Options introduced in 1977)
High Put Volume Low Put Volume
1963-1977:
0.49%
0.25%
1978-1987:
Insignificant
0.42%
1988-1999:
Insignificant
0.37%
FIMA Research Center,
University of Hawai'i
Chen and Singal (2003)
15
In Conclusion
The Bottom Line Message:
“Why Do We Want to Regulate Short
Sales?”
1. Short-Sale Constraints Impede Market Efficiency
2. Short-Sale Constraints Can Not Stop Price Declines
3. Put Options Provide Far More Effective and Less
Costly Way of Creating Short Positions
3. Short-Sales Represent Only a Small Portion of the Total
Market Volume
However, Short-Sales Constraints May be
Justified for Illiquid Stocks or Small-Sized Firm
Stocks
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16
Thank You!