Short selling has not been a major causal factor in recent share price declines or stock market volatility, according to research from Sydney-based
Short selling has not been a major causal factor in recent share price declines or stock market volatility, according to research from Sydney-based hedge fund manager Platypus Capital Management.
Platypus, a quantitative firm with two small long/short hedge funds, examined Dow Jones Industrial Average stock price and short selling data from 1999 to 2008, as well as at the New York Stock Exchange Composite Index and NYSE’s short selling data from 1995 to 2008.
In neither case could the researchers find any statistically significant relationship between increases in short selling and changes in stock prices – nor indeed any link between short selling and stock price volatility. “This was quite a surprising discovery,” says Platypus partner Derek Sicklen.
Short selling has become a controversial practice in the current bear market as company executives and some political leaders have accused short sellers of driving prices down and volatility up, notably for banks and other financial institutions. But Sicklen says: “We couldn’t find any smoking gun.”
The study looked at monthly changes in short selling, as measured by changes in the ratio of short positions to average trading volume, and compared these with monthly changes in stock prices for Dow stocks in the same month as well as with price changes one, two, three and six months later.
The authors repeated the exercise for the NYSE Composite Index, an index of all stocks listed on the New York Stock Exchange that represents around 60 per cent of the market capitalisation of all listed stocks in the world.
In both cases they looked for a meaningful statistical relationship between changes in short selling and changes in share prices, on the one hand, and between changes in short selling and volatility, on the other, but no such relationships emerged from the data.
“It looks like the dramatic sell-off in global equity markets has been driven by institutional and retail holders of stocks heading for the exits, rather than by the actions of speculators shorting stocks,” Sicklen says. “This is probably not a popular conclusion, but it seems to accord with the data.
“But the real problem is that regulatory restrictions on short selling are causing significant redemptions from long/short hedge funds. As most such funds have a long bias, this means that these funds are liquidating mainly long positions en masse to meet redemptions.
“This can only be bad news for equity prices, and a textbook example of the law of unintended consequences where restrictions on short selling can actually increase sales of equities.”
