Short selling took center stage at the ninth edition of this conference organized by the Financial Management departments at IESE, Universidad Carlos III, Instituto de Empresa and CEMFI. These transactions allow investors to speculate on a drop in asset prices. The informational advantages of short sellers when carrying out their transactions and the need for this type of transactions in order to provide liquidity to the market were the most common topics in the studies presented by the professors and international researchers.
The International Center for Financial Research hosted the 9th Madrid Finance Workshop, a joint project between the departments of Financial Management at IESE, Universidad Carlos III, Instituto de Empresa and CEMFI.
This time, the semiannual event featured four notable research papers on short selling and its impact on the financial markets, an issue that has been the focus of much criticism over the past year and is now being closely watched by the regulatory agencies.
One of the biggest criticisms of short sellers is that they try to manipulate prices by artificially trying to decrease prices, increasing volatility and destabilizing markets.
Adam Reed, professor at the University of North Carolina, presented the paper "How Are Shorts Informed? Short Sellers, News and Information Processing," which shows how short sellers operate at the same time as other agents and, in some instances, even later. "It is rather telling that the number of short-selling transactions is higher on the days with a heavy volume of news, and falls on days in which the market does not generate that much information," said Reed.
Still, he explained, there is news that can create major informational advantages for those smart enough to process them properly.
Meanwhile, the article "What do Short Sellers Know?" presented by Prof. Ekkehart Boehmer of the University of Oregon, concludes that short sellers are well-informed about upcoming earnings and are capable of predicting the impact that certain news will have on the market.
Nonetheless, it should be pointed out that these two research projects are based on different data and time frames.
Liquidity in the market: cause or consequence?
Another issue covered in this workshop was how short selling influences liquidity in the market. The paper "Shorting at Close Range: A Tale of Two Types" presented by Prof. Charles Jones, of Columbia University, shows that short-selling transactions can be divided into two groups: those that provide liquidity to the market and those that demand it. The former are characterized by the wide spreads between the bid and ask price, and by initiating or increasing a short position after a strong, last-minute price increase. With the latter, the spreads are relatively small and similar to the long sales that require liquidity. The conclusion is that short sellers play an important role as suppliers of liquidity, thereby helping the market to function more efficiently.
For his part, Alessandro Beber, professor at the University of Amsterdam, analyzed the consequences that the new restrictions instituted by the regulators have had on the markets. As shown in his paper "Short Selling Bans Around the World: Evidence from the 2007-09 Crisis" the restrictions introduced have reduced market liquidity at a time in which it was already low, particularly for small caps, stocks with small market capitalization, and high volatility. Moreover, the measures taken have hindered the process of setting equilibrium prices and yet have failed to keep stock prices up, except in the US.