SAFE Working Paper No. 365

Short Sale Bans May Improve Market Quality During Crises: New Evidence from the 2020 Covid Crash

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.