In theory, banning short selling stabilizes stock prices but undermines
pricing efficiency and has ambiguous impacts on market liquidity.
Empirical studies find mixed and conflicting results. This
paper leverages cross-country policy variation during the 2020 Covid
crisis to assess differential impacts of bans on stock liquidity, prices,
and volatility. Results suggest that bans improved liquidity and stabilized
prices for illiquid stocks but temporarily diminished liquidity
for highly liquid stocks.The findings support theories in which short
sale bans may improve liquidity by selectively filtering out informed—
potentially predatory—traders. Thus, policies that target the most
illiquid stocks may deliver better overall market quality than uniform
short sale bans imposed on all stocks.