Marke-Wde Shor-Sellng Resrcons Anchada Charoenrook and Hazem Daouk + Ths verson: Augus 2005 Absrac In hs paper we examne he effec of marke-wde shor-sale resrcons on skewness volaly probably of marke crashes lqudy and expeced marke reurns or he cos of capal. We repor new daa on he hsory of shor-sellng and pu opon radng regulaons and pracces from he counres ha have a sock exchange and creae a shor-sellng feasbly ndcaor for he analyss of sock marke ndces around he world. We fnd ha shor-sale resrcons do no affec eher he level of skewness of reurns or he probably of a marke crash. When shor-sellng s possble aggregae sock reurns are less volale and here s greaer lqudy. Expeced reurns are lower when shor-sellng s possble and when counres sar allowng shor-sellng aggregae sock prce ncreases. Ths resul dffers from he effec of shor-sellng consrans of ndvdual socks on sock reurns repored n exsng sudes. A he marke level he lower expeced reurn nvesors requre due o lower volaly and ncrease lqudy domnaes he Mller (977) over prcng effec whch appears o domnae a he frm level. Collecvely our emprcal evdence suggess ha allowng shor sales enhances marke qualy. JEL classfcaon code: G5 G2 Keywords: Shor-sale consrans; Sock reurns; Cos of capal; Inernaonal fnance Ths research would no have been possble whou he nformaon we receved from represenaves of he sock markes and foregn naonals n he fnance ndusry whom we conaced. We are deeply ndebed o hem. We would also lke o hank Alex Buler Carole Gresse Ronald Masuls Davd Ng Davd Parsley Hans Soll and semnar parcpans a Cornell Unversy Vanderbl Unversy and he 2003 French Fnance Assocaon meeng for helpful commens. We hank Campbell Harvey for provdng some daa. We hank Kun Qan Rsh Sangal Ahmad Slab and Xng Zhou for careful research asssance. Anchada Charoenrook hanks he Fnancal Marke Research Cener for fnancal suppor. + Anchada Charoenrook: The Owen Graduae School of Managemen Vanderbl Unversy 40 2 s. Avenue Souh Nashvlle TN 37203. Emal: anchada.charoenrook@owen.vanderbl.edu. Hazem Daouk: Deparmen of Appled Economcs & Managemen Cornell Unversy 446 Warren Hall Ihaca NY 4853. Emal: hd35@cornell.edu
Marke-Wde Shor-Sellng Resrcons Absrac In hs paper we examne he effec of marke-wde shor-sale resrcons on skewness volaly probably of marke crashes lqudy and expeced marke reurns or he cos of capal. We repor new daa on he hsory of shor-sellng and pu opon radng regulaons and pracces from he counres ha have a sock exchange and creae a shor-sellng feasbly ndcaor for he analyss of sock marke ndces around he world. We fnd ha shor-sale resrcons do no affec eher he level of skewness of reurns or he probably of a marke crash. When shor-sellng s possble aggregae sock reurns are less volale and here s greaer lqudy. Expeced reurns are lower when shor-sellng s possble and when counres sar allowng shor-sellng aggregae sock prce ncreases. Ths resul dffers from he effec of shor-sellng consrans of ndvdual socks on sock reurns repored n exsng sudes. A he marke level he lower expeced reurn nvesors requre due o lower volaly and ncrease lqudy domnaes he Mller (977) over prcng effec whch appears o domnae a he frm level. Collecvely our emprcal evdence suggess ha allowng shor sales enhances marke qualy. 2
Inroducon Shor-sellng of secures has elced long sandng conroversy. The debae among nvesors raders regulaors and varous marke parcpans on shor-sellng of secures ha began as early as he 600s connues oday. Even n he U.S. where shor-sellng has been allowed under some condons snce before he weneh cenury concerns abou were rased as recen as 2004. 23 Opponens of shor-sellng argue dsrups orderly markes by causng panc sellng hgh volaly and marke crashes. Proponens clam shor-sellng faclaes nformaon ransfer ncreases lqudy and mproves rsk sharng n he economy. Tha fewer han half he exchanges around he world currenly allow shor sales underscores he lack of consensus among regulaors on hs ssue. In he academc communy here s renewed neres n undersandng he effecs of shor-sellng. Lamon and Thaler (2003) and Lamon and Sen (2004) for example sugges ha shor-sale consrans by lmng arbrage played a role n he year-2000 sock marke bubble. Fnance heory suggess shor-sale consrans have mpacs on sock reurn mean volaly skewness as well as lqudy. Wh he excepon of few sudes mos avalable emprcal sudes examne he mpac of shor-sale consrans a he ndvdual sock level usng dfferen proxes for he consrans. 45 Whle hese sudes advance our undersandng of how shor-sale consrans mpac ndvdual sock reurns and many sugges ha shor- See hp://www.prudenbear.com/press_room_shor_sellng_hsory.hml for a revew of he hsory of shor-sale polcy debaes. 2 The U.S. sock marke sared prohbng shor sales on a down ck n 93. In 932 brokers were requred o oban wren auhorzaon from her clens before lendng shares. Shor sales are allowed oday when he curren prce s hgher han he prce of he prevous rade (an upck) or when he curren prce s unchanged from he prevous rade bu hgher han he las rade a a dfferen prce (zero-plus ck). 3 On June 23 2004 he Secures and Exchange Commsson voed o adop new Regulaon SHO under he Secures Exchange Ac of 934. Regulaon SHO provdes a new regulaory framework governng shor-sellng of secures. 4 Mos emprcal sudes of shor-sale consrans focus on s relaon o over prcng of ndvdual socks n he U.S sock marke. These sudes dffer manly n her measures of shor-sale consrans. Arnold Buler Crack and Zhang (2004) Asquh Pahak and Rer (2004) Bren Morse and Sce (990) Dechow Huon Meulbroek and Sloan (2000) Fglewsk (98) Sefeddne and Wlhelm (996) Senchack and Sarks (993) Woolrdge and Dcknson (994) employ shor neres or he change of shor neres as a proxy for he level of shor-sale consrans. Fglewsk and Webb (993) and Danelson and Sorescu (200) employ opon nroducon as proxy for a declne n shor-sale consrans. Jones and Lamon (2002) use lendng fees of socks n he loan crowd from 926 hrough 933. D Avolo (2002) use loan supply and loan fees from an nsuonal lendng nermedary as proxy for shor-sale consran. Mos sudes fnd ha shor-sale consrans are assocaed wh sock overprcng bu a few do no. 5 Some sudes examne volaly. Excep for Kraus and Rubn (2002) and Bollen (998) mos sudes ha examne he effec of opon nroducon (reducon n shor sale consrans) on he volaly of he underlyng sock fnd ha he volaly of sock reurn s lower afer he nroducon of opons (Conrad 989; Sknner 989). 3
sale consrans have a non-neglgble mpac on sock reurns hey provde lle gudance as o how marke-wde resrcons mpac he aggregae marke reurn or he overall qualy of he marke. 6 The mpac of marke-wde resrcons on marke reurns can dffer sgnfcanly from he mpac of shor-sale resrcons on ndvdual socks due o dversfcaon; f shor-sale consrans have dfferenal mpac on dfferen socks hen hey may have no mpac on aggregae marke reurns. In conras f shor-sale consrans affec socks sysemacally hey wll affec aggregae marke reurn and hus affec expeced marke reurn and marke rsk premum. Furhermore ssues such as marke-wde lqudy and he probably of a marke crash need o be suded a he marke level. In hs paper we examne he effec of marke-wde shor-sale resrcons on skewness volaly probably of marke crashes lqudy and expeced marke reurns. The movaon for examnng hese characerscs comes from ssues brough abou by regulaors and from he objecve o asses he valdy of some exsng heores on he effecs of shor-sale consrans. Undersandng how shor-sale consrans affec expeced marke reurns s also mporan because one major purpose of sock markes s o faclae he rasng of capal for frms. We collec new daa on he hsory of shor-sale regulaon and feasbly from counres ha have a sock marke. We also collec daa on he hsory of pu opon radng as Fglewsk and Webb (993) show ha opon radng amelorae shor-sale consrans. A bearsh nvesor may emulae a shor sale by buyng a pu opon. We consder boh he legaly and feasbly of shor-sellng or pu opon radng. We ask abou feasbly because many counres do no have rules prohbng shor-sellng ye no shor-sellng akes place for lack of necessary nsuons ha faclae sock borrowng across marke parcpans. Conversely some counres offcally prohb shor-sellng ye shor-sellng akes place rounely va off-shore markes. We consruc an ndcaor ha deermnes wheher shorsellng s possble usng nformaon on he regulaon and feasbly of boh shor-sellng and pu opon radng. We use hs ndcaor o analyze a subse of he counres for 6 A few sudes examne he overall marke mpac of shor-sale consrans usng emprcal mehods and shorsale consrans measures ha dffer from wha are employed n hs paper. Jones (2002) sudes he change n lqudy around evens ha aler he level of shor-sale consrans n he U.S. sock markes. He fnds ha he nroducon of he requremen ha brokers secure wren auhorzaon before lendng a cusomer s shares n 932 had a negave mpac on lqudy bu he requremen ha shor sellng be execued only on an up ck n 938 had a posve effec on lqudy. Brs Goezmann and Zhu (2003) examne he effec of shor-sale consrans on characerscs of he reurn dsrbuon of ndvdual socks and how shor-sale consrans affec marke effcency. They fnd markes are more effcen when shor-sellng s allowed. 4
whch we have sock ndex daa from December 969 hrough December 2002. Our emprcal analyss ncludes panel regresson ess and even sudes. In all our panel sudes we conrol for counry fxed effecs and a wde array of varables ha may affec crosscounry reurns repored n exsng leraure. We fnd ha when shor-sellng s possble he aggregae reurns are less volale. When shor-sellng s possble here s greaer lqudy especally n down markes. There s no evdence ha shor-sale resrcons affec he skewness of reurns or he probably of a marke crash. The even sudy analyss shows srong evdence ha when sock markes frs allow shor-sellng he prce of he marke ndex ncreases. Ths suggess ha nvesors requre lower expeced reurns on socks when shor-sellng s possble. Resuls from panel regressons also show evdence ha he cos of capal s lower n exchanges where shorsellng s possble. Ths sudy makes hree conrbuons o he exsng leraure. A parcular conrbuon s ha we repor regulaon and feasbly of shor sales and pu opons radng n counres and use a subse of hs daa o analyze he effec of shor-sellng resrcons; he daa conss of broader range of counres han ypcally suded. Second hs sudy provdes drec evdence ha helps resolve he queson of wheher shor-sellng should be allowed. Collecvely our emprcal fndngs lead us o conclude ha allowng shor sales enhances marke qualy. Fnally our fndngs show ha marke-wde shor-sellng resrcons affec marke reurns. Sgnfcanly we fnd ha expeced reurns are lower when shor-sellng s possble and when counres sar allowng shor-sellng aggregae sock prce ncreases. Ths resul dffers from exsng emprcal evdence a he frm level whch repors declne shor-sale consrans are relaed o lower fuure reurns. Ths dfference appears o be because a he marke level he lower expeced reurn nvesors requre due o lower volaly and ncrease lqudy domnaes he Mller (977) over prcng effec. The remander of he paper s organzed as follows. Secon I develops hypoheses on he effec of shor-sellng resrcons on marke reurns and lqudy from exsng heores. Secon II descrbes he daa we colleced on shor-sellng and pu opons radng. Secon III descrbes oher marke daa used n our analyss. Secon IV repors our fndngs on skewness and volaly of reurns marke crashes and lqudy. Secon V repors our fndngs on expeced reurns or he cos of capal. We conclude and dscuss he mplcaons of our fndngs n Secon VI. 5
I. The effec of shor-sellng consrans Ths secon develops esable hypoheses on he effec of shor-sellng from exsng heores. A. Skewness Accordng o Mller (977) when shor-sellng s prohbed and nvesors have heerogeneous belefs prvae nformaon of bullsh nvesors s slowly fed no prces hrough sock radng as hey are avalable bu he prvae nformaon of nformed raders who are bearsh and do no own socks are no ncorporaed no prces. Subsequenly when marke nformaon s revealed hrough naure or publc announcemen because negave news has no been dssemnaed here are greaer sock marke prce adjusmens for bad news han good news. Even when he dsrbuon of news s symmerc ex ane he realzed sock reurn dsrbuon s more negavely skewed due o larger negave shocks when shor-sellng s no possble. Hong and Sen (2003) propose a model o explan why large marke declnes can occur n he absence of news. Ther model also produces negavely skewed reurns when shor-sellng s no possble. Hypohess : Sock marke reurns are more negavely skewed n markes where shorsellng s no possble. B. Volaly There s no wdely acceped heory on how shor-sale consrans affec he volaly of marke reurns. Kraus and Rubn (2002) derve a hghly sylzed model predcng he mpac of ndex opons nroducon (a form of reducon n shor-sale consrans) on he volaly of sock reurns when shor-sellng of socks s prohbed. Ther model predcs volaly may ncrease or declne dependng on he model parameer values. Lackng a reason o predc he drecon of he effec on volaly we examne Hypohess 2. Hypohess 2: The volaly of he marke reurn dsrbuon dffers n markes where shorsellng s possble and where s no. C. Lqudy Damond and Verreccha (987) examne he effec of shor-sale consrans on he adjusmen speed of secury prces. Ther model predcs an ncrease n he bd-ask spread 6
and a declne n lqudy when shor-sellng s no possble. The declne n lqudy s due o dmnshed supply of socks for sale because some nvesors who wan o sell bu do no already own socks canno ake par n he marke. In he Damond-Verreccha model nvesors canno shor sell bu he marke maker can n order o absorb buyng demand from nvesors. When we mach he Damond-Verreccha model o our emprcal seng we cas marke makers as ownng a large nvenory of sock so hey can buy or sell from her nvenory bu no acually shor sell. When we classfy a marke as no allowng shor sales n mos markes an nernal borrowng of secures whn a fnancal nsuon may sll be possble. Thus we es Damond-Verreccha s predcons. Hypohess 3: There s less lqudy n markes where shor-sellng s no possble. D. Expeced reurn and he cos of capal Shor-sellng resrcons affec expeced marke reurns n wo ways. Frs our emprcal analyss demonsraes ha when shor-sellng s possble marke reurns are less volale and here s greaer lqudy. Varance rsk and lqudy are deermnans of expeced reurn. 7 Snce counry-specfc varance rsk s no compleely dversfable across counres n a less han fully negraed global fnancal marke nvesors should requre a lower expeced reurn when varance rsk s lower and lqudy s greaer whch s when shorsellng s possble (see for example Bekaer and Harvey 995). Second shor-sellng allows nvesors o beer share rsks from her dfferen endowmens; shor-sellng self provdes a more complee marke. When nvesors can share her endowmen rsks n a more effcen manner hey requre lower rae of reurn for her nvesmens. Ths s also welfare mprovng (Ross 976). For hese reasons we es Hypohess 4. Hypohess 4: The cos of capal s lower n counres where shor-sellng s possble han where s no. E. Sock prce change when shor-sellng prohbon s lfed There are wo opposng forces ha affec prce changes when shor-sellng prohbons are lfed. The frs s Mller (977) s overprcng effec. When shor-sellng s prohbed and nvesors have heerogeneous belefs only he valuaon of he bullsh 7 There s ample emprcal evdence ha lqudy s a deermnan of expeced reurns. For evdence on lqudy see Amhud and Mendelson (986) Chorda Roll and Subrahmanyam (2000) Hasbrouck and Sepp (200) Huberman and Halka (2000) and Pasor and Sambaugh (2003). 7
nvesors and he bearsh nvesors who currenly own he sock s regsered n he sock prce. Bearsh nvesors who do no own he sock do no parcpae n he marke so her valuaons are no regsered n he sock prce. Hence on average socks are over valued compared o he full-nformaon prces and sock prces declne when he shor-sellng prohbon s lfed. On he oher hand f expeced reurns are lower when shor-sellng s allowed sock prces should ncrease when shor-sellng prohbon s lfed provded ha expeced fuure cash flows are consan durng hs ranson perod. Theorecally eher of hese wo effecs may domnae. Wha happens o he sock prces when a shor-sellng prohbon s lfed s an emprcal queson. Hypohess 5: The aggregae marke prce changes when a shor-sellng prohbon s lfed. II. Legaly and feasbly of shor-sellng and pu opons radng We collec daa on he legaly and he feasbly of shor-sellng and operaon of pu opons radng n all sock markes around he world. Tweny-hree of he counres are classfed as developed markes and 88 as emergng markes accordng o Morgan Sanley Capal Inernaonal Inc. classfcaon. We surveyed hese markes and dervaves exchanges f here were such a separae eny durng he second half of 200 and durng 2002. Our survey leer asked wheher he sock marke allows shor-sellng and f yes wha s he frs dae was allowed. We also asked wheher shor-sellng was feasble n pracce and f yes when was he frs dae was feasble. We asked hs second queson because many counres do no ban shor-sellng bu a he same me no shor-sellng can acually ake place because here are no enablng regulaons and facles. Then agan a counry lke Sngapore offcally prohbs shor-sellng bu rounely akes place va offshore markes. The acual feasbly of shor-sellng should have a sronger nfluence han smple legaly on capal markes. We also asked wheher pu opons were avalable for radng and f yes as of wha dae. Wherever possble we cross-checked answers agans he 2000 edon of he Inernaonal Encyclopeda of he Sock Marke he 2000 edon of he Handbook of World Sock Dervave and Commody Exchanges and wh varous foregn naonal praconers. 8
A. Shor-sellng Table I repors he legaly and he feasbly of shor sales. Mos developed counres excep for Sngapore currenly allow shor sales. Many of hese counres have always allowed hem barrng a few emporary moraorums around he me of World War II. A he same me many emergng counres have esablshed laws or polces allowng shor sales. The laes emergng counry o offcally allow shor sales s Peru (2002). In 2002 95 percen of developed counres allowed shor sales compared o 3 percen of emergng counres. Before 990 he respecve fgures were 64 percen and 0 percen. The acual feasbly of shor-sellng s dffcul o measure. We rely on exchange offcals academcs and ndusry connecons o classfy he counres n erms of feasbly of shor-sellng. Eghy sx percen of developed counres repor ha shor-sellng s feasble n pracce bu only 2 percen of emergng markes repor ha shor-sellng s feasble. Before 990 he respecve fgures were 68 percen and 6 percen. Fgure graphs he hsory of he legaly and feasbly of shor-sellng and pu opon radng n he 20 h cenury. I plos he me seres of he number of counres n he world he number of counres wh sock markes he number of counres ha allow shor-sellng and he number of counres where shor-sellng s feasble. 8 I s apparen from Fgure ha before he 990s whle he number of counres wh sock markes ncreased subsanally he number of counres allowng shor-sellng dd no ncrease a he same rae; he rao acually declned. Only afer 990 do we see a sgnfcan ncrease n he number of counres allowng shor-sellng. In counres ha sared allowng shor-sellng offcally polcy dd no necessarly ranslae no pracce. In fac we see a wder gap beween he number of counres ha offcally allow shor-sellng and he number of counres where shor-sellng s feasble wdened n he 990s. Fgure shows a clear pcure ha polcy markers have no reached a consensus on wheher o perm and faclae shor-sellng. C. Pu Opons radng Table II repors he legaly and operaon of pu opons radng. U.S. s he frs 8 The daa for he number of counres n he world come from he 2002 CIA World Facbook. We obaned he dae of ncorporaon of a sock marke from he 2000 Handbook of Sock Dervave and Commody Exchanges or else he webse of he counry s sock exchange. e ha he number of counres wh sock markes also ncludes counres whose sock markes were emporarly closed due o a crss. 9
counry o rade pu opons. In 2002 here was pu opons radng n 9 percen of developed counres and 9 percen of emergng counres. Before 990 he respecve fgures were 55 percen and percen. Counres may have dfferen polces on shor-sellng and pu opons radng. For example n Inda shor-sellng s uncommon and s prohbed o foregn nvesors. We have classfed Inda as never allowng shor-sellng. Pu opons however were nroduced n July 200 afer he Kean Parekh scam. Inda s SEBI s (s SEC) waned o encourage pracces n lne wh he norms of developed markes and o provde a hedgng ool for nvesors whle a he same me dscouragng speculaors. Israel also does no allow shorsellng bu has pu opons radng. Oher counres naed pu opons radng before hey sared o allow shor-sellng. Chle s one example. The correlaon beween he exsence of pu opons radng and shor-sellng s 0.34 whch suggess ha consderng shor-sellng feasbly alone gves an ncomplee accoun of he ably of nvesors o ake posons ha are effecvely shor posons. We consruc a bnary varable ha reflecs he ably of nvesors o ake shor posons eher hrough he exsence of shor-sellng or pu opons radng and employ n he emprcal analyss. We label hs varable SSPO feasbly. For each counry n each monh SSPO feasbly equals one f eher shor-sellng or pu opons radng s possble. I equals zero oherwse. III. Daa A. Sock marke varables Monhly equy ndces are avalable from Daasream daabase for 23 developed markes and 34 emergng markes. The daa range from December 969 hrough December 2002. These are value-weghed ndces calculaed wh dvdend rembursemen. We ake he MSCI value-weghed world ndex as a proxy for he world marke porfolo. 9 We compue monhly skewness as: 9 The MSCI World Index s an ndex of only developed counres. I begns n December 969. In prncple he MSCI All-Counry World Index whch ncludes more counres mgh be a beer choce bu n pracce because s avalable only snce December 987 and has a 0.9968 correlaon wh he MSCI World Index MSCI World Index s a beer choce. 0
= = n r r n n n sk 3 ) ˆ ( 2) )( ( τ τ σ () where = = n r r n 2 2 ) ( ) ( ˆ τ τ σ. r τ s he daly reurn of day τ n monh of he ndex of counry and r s he mean reurn of monh ; n s he number of daly observaons n monh. We compue condonal varance of daly reurn as: = = n r r n 2 2 ) ( ) ( ˆ τ τ σ. Followng Bollerslev Engle and Wooldrge (988) we also examne he condonal volaly of monhly reurns usng a mulvarae ARCH model specfed as: 0 0 ~ 6 3 2 6 3 2 6 3 2 3 3 2 2 3 3 2 3 2 2 2 2 2 2 3 2 2 2 2 + + + = + + + = + + + = + = + = w w w w w w w w w w w w w w h h h h N a b h a b h a b h c r c r ε ε ε ε ε ε ε ε ε ε ε ε ε ε ε ε (3) where r and r w s he dollar monhly reurn of he sock marke ndex and he world marke ndex n monh ; j ε s he nnovaon n monhly reurn of he sock marke ndex of counry n monh -j ; h w s he condonal varance of he monhly reurn of he sock marke ndex of he world n monh ; h s he condonal varance of he monhly reurn of he sock marke ndex of counry n monh. The condonal volaly of monhly reurns s he square roo of h. We esmae he model n (3) usng maxmum lkelhood. As n Engle Llen and Robns (987) he weghs of he lagged resdual vecors are aken o be /2 /3 and /6. The consans 2 a b 2 and c 2 are consraned o be dencal for every counry-world par.
We defne a bnary monhly crash varable o denfy a monh ha he sock marke drops more han wo sandard devaons. The sandard devaon s he average of he prevous hree monhs. The varable crash = f r < 2σ crash s defned as: crash = 0 oherwse where σ ˆ ˆ ˆ σ σ 2 σ 3 = ( + + )/3. We measure lqudy usng urnover. Turnover s defned as he rao of volume of dollar rade per monh o dollar marke capalzaon a he end of he monh. Damond and Verreccha (987) also predc ha prohbng shor sales reduces lqudy more when sock prces declne han when hey ncrease. We use asymmerc volume o capure hs asymmery n lqudy. Monhly asymmerc volume for counry s defned as: where Vol VA = n τ n Vol D Vol ( D ) n τ τ τ τ τ τ n D τ τ n τ Vol n τ τ ( D ) s he daly dollar volume for day τ n monh τ (4) D s a dummy varable ha akes he value f he reurn on day τ s posve and 0 f s negave and n s he number of daly observaons n monh. B. Conrol varables Sulz (999) pons ou ha lberalzaon reduces he cos of equy. Bekaer and Harvey (2000) and Henry (2000) repor ha fnancal marke lberalzaon reduces he cos of equy. They also show affecs lqudy volaly and poenally oher varables of neres n our analyss. We conrol for he confoundng effecs of lberalzaon n all our regresson ess. The ndcaor varable lberalzaon changes from zero o one n he monh afer he offcal lberalzaon. We use lberalzaon daes from Bekaer and Harvey (2000) and from Bae Baley and Mao (2003). Chen Hong and Sen (200) repor ha lagged reurn and lagged rend-adjused urnover predc skewness. We nclude hem as conrol varables n ess of skewness. Lagged rend-adjused urnover s defned as n Chen Hong and Sen (200). 2
Ferson and Harvey (993) and Dumas and Solnk (995) repor reurns of an ndex of a counry may also vary wh s exchange rae. In ess of expeced reurns we conrol for exchange rae varaon by ncludng monhly foregn exchange raes from Inernaonal Fnancal Sascs. There may be oher dfferences across counres ha we do no explcly model. To conrol for such dfferences we use a counry-fxed-effec dummy. We fnd he same resuls when we conduc he analyses whou a counry-fxed effec dummy bu ncludng addonal conrol varables: GDP growh shareholders rghs exchange rae rsk and lqudy. IV. Shor-sale resrcons marke reurns and lqudy In hs secon we repor he emprcal es resuls of he relaon beween shor-sale resrcons skewness volaly marke crash and lqudy. Table III repors sample sascs. All panel leas square regressons nclude a counry-specfc dummy varable (no repored) n addon o he repored conrol varables. All repored regresson esmaes are correced for counry-specfc heeroskedascy and counry-specfc auocorrelaon. A. Shor-sale resrcons and skewness To examne he relaon beween skewness and shor-sale resrcons we esmae panel regressons of monhly skewness on SSPO feasbly conrollng for lberalzaon lagged reurn lagged derended urnover and a me rend. Panel A of Table IV repor hese panel regresson esmaes. For hose counres ha had a shor-sellng regme change whch also have skewness daa around he even dae we compare he average skewness pre- and pos-even. We compare he average skewness over a wo-year pre-even perod and a wo-year pos-even perod. We also es usng a fve-year pre- and pos- even perods. Panel B of Table IV repors he pre- and pos-even averages of skewness her dfference and he p-value esng he hypohess ha here s no change n average skewness before and afer shorsellng feasbly changed. The es resuls n boh Panels A and B ndcae ha shor-sellng resrcons have no mpac on he skewness of he aggregae marke reurn dsrbuon. B. Shor-sale resrcons and volaly 3
Panel A of Table V repors coeffcens of panel regressons of reurn varance on SSPO feasbly conrollng for lberalzaon and me-rend. Excludng he me rend gves smlar resuls. We repor resuls of ess wh condonal varance of daly reurns and monhly reurns from he ARCH model n equaon (3). Excep for he case of monhly varance of developed counres he coeffcen esmaes of SSPO feasbly n all he oher cases are negave and hghly sascally sgnfcan. The coeffcens are economcally sgnfcan as well. The coeffcen of SSPO feasbly n column 2 s -0.0024 whch means ha he sandard devaon of monhly reurns n counres ha allow shor-sellng and hose ha do no dffer by 0.05. These resuls show ha he aggregae marke reurn s less volale when shor-sellng s possble. C. Shor-sale resrcons and marke crash The varable crash equals one n monhs wh a negave reurn of hgher han 2 sandard devaons where he sandard devaon of reurns s he average of sandard devaon reurns durng he prevous hree monhs. Table VI repors coeffcen esmaes of panel log regressons of crash on SSPO feasbly conrollng for lagged volaly and lberalzaon. Resuls are smlar for panel prob regressons. The resuls show ha he feasbly of shor-sellng has no relaon o he probably of a marke crash. D. Shor-sale resrcons and lqudy We use urnover as a proxy for lqudy. To mgae he effec of oulers whch occur because he denomnaors are small n some counres we ake he naural logarhm of hs rao. Table VII repors panel regressons of urnover on SSPO feasbly conrollng for lagged absolue reurn lagged volaly lberalzaon and a me rend. The coeffcen esmaes of SSPO feasbly are posve and hghly sgnfcan n all regressons. The relaon beween urnover and SSPO feasbly s also economcally sgnfcan. A coeffcen of 0.3422 (column 3 of Table VII) ranslaes no 5 percenage pons hgher urnover when shor-sellng s possble. These resuls suppor he predcon by Damond and Verreccha (987) ha here s reduced lqudy when shor-sellng s no possble. Damond and Verreccha (987) also predc less lqudy n a down marke han n an up marke when shor-sellng s no possble. Tha s volume asymmery (VA) should be lower when shor-sellng s possble han when s no. Table VIII repors coeffcens of panel regressons of VA on SSPO feasbly conrollng for lberalzaon (columns 3 and 4
5). The asymmery n volume s negave and sgnfcan only n developed markes and no n emergng markes. Regulaors who oppose shor-sellng ofen argue ha n a large marke declne speculave shor-sellers wll flock o he marke ncrease panc sellng ncrease down-marke volume and cause larger marke declne han f speculave shor-sellers were no presen. Ths lne of argumen predcs ha VA should be lower when shor-sellng s possble bu even more so when here s sgnfcan marke declne or a marke crash. To examne he relaon beween VA shor-sale consrans and marke crash we esmae a panel regresson of volume asymmery on SSPO feasbly crash and an neracon erm SSPO feasbly crash conrollng for lberalzaon. If opponens of shor-sellng are correc hen we should expec he neracon erm o be negave. In oher words we expec he feasbly of shor-sellng o be assocaed wh a more negave volume asymmery when here s a crash. The coeffcen esmaes of hs regresson are n Columns 2 4 and 6 of Table VIII. The coeffcen of he neracon erm s no sgnfcanly dfferen from zero lendng no suppor o hs argumen. V. Shor-sale consrans and he cos of capal To examne he effec of shor-sale consrans on he cos of capal we employ an even sudy and panel regressons usng wo proxes for he cos of capal. An even sudy has he advanage ha drecly measures he dscree equy prce change ha should occur f here s a change n he cos of equy and sock prce caused by a change n shor-sellng rules. I s unnfluenced by oher macroeconomc condons ousde he even wndow or by dfferences among counres. Henry (2000) uses he same mehod o sudy he effec of lberalzaon on he cos of equy. A. Even sudy Our analyss uses he acual dae change n shor-sellng rules as he even dae and no he announcemen dae for several reasons. Frs he pessms nvesors who dd no rade due o shor-sellng resrcons can sar radng only when he pracce s mplemened so her effec on he level and on he volaly of he sock prce occurs on he mplemenaon dae. Second from a heorecal perspecve he expeced reurn may ncrease or declne when shor-sellng resrcons are lfed. The wld card s he effec on 5
volaly whch may eher ncrease or declne when shor-sellng s possble. Because of hs uncerany nvesors may reac o he news on he mplemenaon dae when hs uncerany s resolved. Perhaps mos mporan when rules allowng shor sales are frs announced n many cases s unceran wheher wll be mplemened a all wheher wll be mplemened n a mely manner and wheher f shor-sellng would acually be feasble. Wll he nsuonal nfrasrucure suppor shor sales? How cosly wll be o shor? Wll here be marke makers wllng o rade on a shor poson? These unceranes are lkely o keep nvesors from reacng o announcemens of shor sale rule changes even when hey hnk hey can predc he marke reacon o a change n shor-sellng resrcons. As he mplemenaon dae nears hese unceranes are resolved so we should deec a gradual marke reacon shorly before he mplemenaon and a he mplemenaon dae. Conrad (989) also fnds change n shor-sale consrans such as nroducon of opon radng affecs prce around he mplemenaon dae and no he announcemen dae. We colleced daa on he specfc daes an exchange sared allowng shor sales or pu opons radng for 3 evens. We use he perods from -30 days o -30 days and from +30 days o +30 days o esmae he world marke CAPM whch s used o calculae he excess abnormal reurns durng he even wndow. Reurns are calculaed usng closng prces of each counry ndex and he world marke ndex. Table IX presens he abnormal reurns and he cumulave abnormal reurns (CAR) from fve days before he even dae o fve days afer he even dae. Columns and 2 repor abnormal excess reurns and cumulave abnormal excess reurns consderng boh shor-sellng rule change and pu opon nroducon evens. Columns 3 and 4 repor CARs consderng only shor-sellng rule change even. Columns 5 and 6 repor CARs consderng only pu opon radng change even. The CARs around he evens ha relax shor-sellng resrcons are mosly posve. In column 2 he CAR over he -day perod for all evens s 3.6% whch s economcally sgnfcan. We es he sascal sgnfcance of hs CAR usng he mehodology proposed by Brown and Warner (985) and usng a sandard error esmaed for he -day perod. The -sasc of 2.5 rejecs he hypohess ha he CAR equals zero a he 5% sgnfcance level. Fgure 2 graphs he CARs for wo calendar monhs (40 radng days) around he even dae. The shaded area n he fgure hghlghs he 20 radng days around he even. 6
The CARs are ncreasng n hs shaded regon and are que fla ousde. The CARs gradual ncrease sarng approxmaely egh radng days before he even dae and connues o ncrease for he nex en radng days. Ths gradual ncrease n he marke prce pror o he mplemenaon dae s conssen wh he dea ha nvesors know abou rule change from pror announcemens bu are unceran abou acual mplemenaon and he feasbly of shor-sellng unl several days pror o he mplemenaon dae. Evdence from our even sudy shows ha relaxng shor-sellng resrcons resuls n a sgnfcan declne expeced reurns. We have noed wo forces drvng he aggregae marke prce change when shor-sellng resrcons are lfed: Mller s overprcng effec and he change n he marke requred rae of reurn due o lower varance rsk ncreased lqudy and mproved rsk-sharng n he economy. If he overprcng effec domnaes we should see marke prces declne when shor-sellng resrcons are lfed. If he requred expeced reurn effec domnaes we should see marke prces ncrease when shor-sellng resrcons are lfed. Our fndngs sugges ha he laer effec s domnan a he aggregae marke level. A he frm level some sudes of U.S. socks fnd reduced shor-sellng resrcons are assocaed wh lower sock prce or lower subsequen reurn (Jones and Lamon 200). Do our fndngs conradc evdence a he frm level? In a hghly negraed marke such as he U.S. sock marke he ncrease n frm-specfc rsks can be dversfed away. Therefore reduced varance and ncreased n lqudy whch arse wh reduced shor-sale consrans a he frm level may no affec her expeced sock reurns. Mller s overprcng effec however affecs ndvdual sock prces as long as here are bearsh nvesors who canno shor sell. Thus s lkely ha he overprcng effec domnaes a he frm level; sock prces declne when shor-sellng consrans are reduced. Our fndngs do no conradc prevous evdence a he frm level and hey hghlgh he dfferen effec of marke-wde resrcons on he aggregae marke reurn and he effec of frm-level consrans on frm reurns. The choce of an asse prcng model usually has lle mpac on an even sudy because he even wndow s narrow dmnshng he mpac of fundamenal rsk adjusmen. neheless we carred ou robusness checks by calculang excess abnormal reurns n a number of ways: () as daly excess reurns mnus each counry s own mean excess reurn (2) as daly excess reurns less daly excess world marke ndex reurns and (3) as excess reurns whou rsk adjusmens. Our conclusons do no change. 7
B. Cross-counry ess We also examne he effec of shor-sellng resrcons on he cos of capal usng panel regressons. A counry s cos of capal s he requred rae of reurn whch we measure usng wo approaches: () he cos of equy compued from counry ndex reurns afer accounng for sysemac rsks and (2) counry cred rangs. In he frs es we adop he nernaonal asse prcng model proposed by Bekaer and Harvey (995). Ths model allows a counry o evolve from a developng segmened marke where rsk s measured by he counry s varance o a counry negraed wh world equy markes where rsk s measured by he sensvy of a counry s equy reurns o movemens n he world marke porfolo. The specal case of complee negraon where he world facor s he only facor s nesed n hs model. We esmae a smplfed verson of Bekaer and Harvey (995) s model n our compuaons of he rsk-adjused excess equy reurns. ( φ ) λvarh e r rf = 0 + φ λcovh w + + α (5) where r s he dollar monhly reurn of he sock marke ndex of counry n monh ; r f s he monhly reurn of he one-monh U.S. T-Bll n monh ; α 0 s a consan ha would be esmaed; φ s a measure of he level of negraon of counry n monh ; λ s he cov prce of he covarance rsk ha would be esmaed; h w s he condonal covarance of he monhly reurns of he sock marke ndex of counry wh he monhly reurn of he world ndex n monh ; λ s he prce of own counry varance rsk ha would be esmaed. We var resrc λ o be he same across all counres. h var s he condonal varance of reurns of he sock marke ndex of counry n monh ; and e s he resdual error erm. We esmae equaon (5) usng non-lnear leas squares esmaes. The resuls are presened n Panel A of Table X. The ndependen varables n model (5) condonal covarance h w and condonal varance h are separaely esmaed par-wse for each counry and he world from he mulvarae ARCH model n equaon (3). The ndependen varable φ n model (5) measures he level of negraon wh he world marke of counry n monh. I s compued as n Bekaer and Harvey (997): 8
expors + mpors exp a gdp φ =. (6) expors + mpors + exp a gdp φ s zero when a counry s no negraed n he world marke; s one when a counry s fully negraed. Panel A of Table X repors he rsk premum esmaes for covarance rsk and varance rsk. Lke Bekaer and Harvey (997) we fnd ha a counry s expeced reurn s deermned by boh he covarance rsk and he counry s own varance rsk. Boh rsk premum esmaes are posve. The resdual from equaon (5) whch measures excess abnormal monhly reurns s used as he dependen varable n he panel regressons. Panel B of Table X repors regressons of he resdual erm e on SSPO feasbly conrollng for lberalzaon foregn exchange rsk and counry-fxed effecs. The coeffcens esmaes of SSPO exsence n all regressons are negave whch ndcaes ha he cos of capal s lower when shor-sellng s possble. However he coeffcens are no sascally sgnfcan a he 5% level. A common dffculy n nernaonal fnance s obanng expeced reurn from equy reurns for a large number of counres due o lmed equy daa from 57 counres. Erb Harvey and Vskana (996) propose usng he counry cred rang from Insuonal Invesor s sem annual survey of bankers as a proxy for expeced reurn. Ths survey s obaned from 75 o 00 banker rangs of each counry s cred worhness on a scale of 0 o 00. Erb Harvey and Vskana (996) show ha he cred worhness measure s a very good proxy for sysemac rsk n he equy markes. For counres for whch equy ndces are avalable he log of counry cred rang racks he expeced reurn of equy as well as or beer han oher avalable measures parcularly n segmened emergng economes. We hus use hese counry cred rangs as our second proxy for expeced reurns allowng us o ncrease our daa sample from 57 counres o 99 counres. Table XI repors panel regressons of he log of counry cred rang on SSPO feasbly conrollng for lberalzaon and counry-fxed effecs. The coeffcen esmae for all-counres sample s 0.03 and s sascally sgnfcan a he % level. Exhb 4 n 9
Erb Harvey and Vskana (996) shows ha an ncrease of one n he log of a counry s cred rang decreases he cos of equy by 0.47 percenage pons. Ths mples ha he cos of equy s lower by.07 (0.03 0.4) percenage pons per year when shor-sellng s possble. The nfluence of shor-sale resrcons appears sronger n emergng counres compared o developed counres; he magnude of he coeffcen of SSPO feasbly s hgher and he p-value s lower for emergng counres. VI. Dscussons and concludng remarks In hs paper we provde emprcal evdence on how marke-wde shor-sellng resrcons affec aggregae marke reurns and on wheher shor-sellng should be allowed. We examne he effec of marke-wde shor-sale resrcons on skewness volaly he probably of marke crashes lqudy and marke expeced reurns and he cos of capal. Our sudy provdes a number of mplcaons. Frs we examne how well curren heores work for marke-wde shor-sellng resrcons and marke reurns. We confrm heorecal predcons on lqudy; we fnd reduced marke lqudy when shor-sellng s no possble. However we fnd shor-sellng resrcons have no effec on skewness of marke reurns or marke crashes as some heores predc. There s srong emprcal evdence ha volaly s lower when shor-sellng s possble alhough he heorecal predcons are ambguous. Our fndng on volaly s smlar o some fndngs repored n emprcal sudes a he frm level ha volaly declnes when shor-sellng consrans declne. Second he effec of shor-sellng resrcons on aggregae marke reurns dffers from ha on ndvdual frm reurns repored n exsng leraures. Shor-sellng prohbon can ncrease expeced reurns due o hgher marke volaly and lower marke lqudy. I can also cause he aggregae marke o be over prced because nformaon of pessmsc nvesors who canno shor sale s no ncorporaed n he marke prce whch mples ha when shor-sellng resrcons are lfed sock prces declne. Our emprcal evdence shows ha expeced reurns are lower when shor-sellng s possble and he marke prce ncreases when shor-sellng resrcons are lfed. Frm level shor-sellng resrcons can also affec ndvdual sock reurn dsrbuons. Bu f hese effecs dffer among frms hey are dversfed away and do no affec he expeced reurn requred by nvesors. Shor-sellng 20
resrcons can also cause overprcng of ndvdual socks. Our fndng on expeced reurn a he marke level appears conrary o many oher emprcal sudes of shor-sale consrans and expeced reurn a he ndvdual sock level whch fnd sock prce declne when shorsellng resrcons are lowered. We conclude ha whle n many cases he overprcng effec may domnae a he ndvdual sock level he lower requred expeced reurn domnaes a he marke level. Ths dsncon has no been made explc n he leraure so far. Fnally we fnd no evdence ha shor-sellng dsrups orderly markes by causng panc sellng hgh volaly or marke crashes. Our emprcal evdence shows overall ha allowng shor sales enhances marke qualy. 2
References Amhud Y. and H. Mendelson 986 Asse Prcng and he Bd-Ask Spread Journal of Fnancal Economcs 7 223-249. Arnold T. A. Buler T. Crack and Y. Zhang 2005 The Informaon Conen of Shor Ineres: A Naural Expermen Journal of Busness forhcomng. Asquh P. P. Pahak and J. Rer 2004 Shor Ineres and Sock Reurn workng paper MIT. Bae K. H. W. Baley and C. X. Mao 2003 Sock Marke Lberalzaon and he Informaon Envronmen workng paper Cornell Unversy. Bekaer G. and C. Harvey 995 Tme-Varyng World Marke Inegraon Journal of Fnance 50 403-444. Bekaer G. and C. Harvey 997 Emergng Equy Marke Volaly Journal of Fnancal Economcs 43 29-77. Bekaer G. and C. Harvey 2000 Foregn Speculaors and Emergng Equy Markes Journal of Fnance 55 565-63. Bollerslev T. R. F. Engle and J. M. Wooldrdge 988 A Capal Asse Prcng Model wh Tme-Varyng Covarances Journal of Polcal Economy 96 6-32. Bollen N. 998 A e on he Impac of Opons on Sock Reurn Volaly Journal of Bankng and Fnance 22 82-9. Bren A. D. Morse and E. K. Sce 990 Shor Ineres: Explanaons and Tess Journal of Fnancal and Quanave Analyss 25 273-289. Brs A. W. N. Goezmann and N. Zhu 2003 Effcency and he Bear: Shor Sales and Markes around he World workng paper Yale Unversy. Brown S. and J. Warner 985 Usng Daly Sock Reurns: he Case of Even Sudes Journal of Fnancal Economcs 4 3-3. Cao H. J. D. Coval and D. Hrshlefer 2002 Sdelned Invesors Tradng-Generaed News and Secury Reurns Revew of Fnancal Sudes 5 65-648. Chen J. H. Hong and J. C. Sen 200 Forecasng Crashes: Tradng Volume Pas Reurns and Condonal Skewness n Sock Prces Journal of Fnancal Economcs 6 345-38. Chorda T R. Roll and A. Subrahmanyam 2000 Commonaly n Lqudy Journal of Fnancal Economcs 56 3-28. Conrad J 989 The Prce Effec of Opon Inroducon Journal of Fnance 44 487-498. D Avolo G. 2002 The Marke for Borrowng Sock Journal of Fnancal Economcs 66 27-306. Dechow P. M. A. P. Huon L. Meulbroek and R. G. Sloan 2000 Shor-Sellers Fundamenal Analyss and Sock Reurns Journal of Fnancal Economcs 6 77-06. Damond D. W. and R. E. Verreccha 987 Consrans on Shor sellng and Asse Prce Adjusmen o Prvae Informaon Journal of Fnancal Economcs 8 277 32. 22
Dumas B. and B. Solnk 995 The World Prce of Foregn Exchange Rsk Journal of Fnance 50 445-479. Engle R. D. Llen and R. Robns 987 Esmang Tme-Varyng Rsk Prema n he Term Srucure: The ARCH-M Model Economerca 55 39-408. Erb C. C. Harvey and T. Vskana 996 Expeced Reurns and Volaly n 35 Counres Journal of Porfolo Managemen 22 46-59. Ferson W. and C. Harvey 993 The Rsk and Predcably of Inernaonal Equy Reurns Revew of Fnancal Sudes 6 527-566. Fglewsk S. 98 The Informaonal Effecs of Resrcons on Shor Sales: Some Emprcal Evdence Journal of Fnancal and Quanave Analyss 6 463-476. Fglewsk S. and G. Webb 993 Opons Shor Sales and Marke Compleeness Journal of Fnance 48 76-777. Glosen L. R. and P. R. Mlgrom 985 Bd Ask and Transacon Prces n a Specals Marke Wh Heerogeneously Informed Traders Journal of Fnancal Economcs 4 7-00. Handbook of World Sock Dervave and Commody Exchanges 2000 Inernaonal Fnancal Publcaons London. Harvey C. 995 Predcable Rsk and Reurns n Emergng Markes Revew of Fnancal Sudes 8 773-86. Harvey C. R. and A. Sddque 2000 Condonal Skewness n Asse Prcng Tess Journal of Fnance 55 263-295. Hasbrouck J. and D. Sepp 200 Common Facors n Prces Order Flows and Lqudy Journal of Fnancal Economcs 59 383-4. Henry P. 2000 Sock Marke Lberalzaon Economc Reform and Emergng Marke Equy Prces Journal of Fnance 55 529-564. Hong H. and J. C. Sen 2003 Dfferences of Opnon Shor-Sales Consrans and Marke Crashes Revew of Fnancal Sudes 6 487-525. Jones C. M. 2002 Shorng Resrcons Lqudy and Reurns workng paper Columba Unversy. Jones Charles M. and Owen A. Lamon 200 Shor Sale Consrans and Sock Reurns workng paper Naonal Bureau of Economc Research. Kraus Alan and Amr Rubn 2002 The Effec of Index Opon Inaon on Volaly n he Presence of Heerogeneous Belefs and Shor Sale Consrans workng paper Unversy of Brsh Columba. Lamon O. A.. and J. C. Sen 2004 Aggregae Shor Ineres and Marke Valuaons Amercan Economc Revew 94 29-32. Lamon O. A. and R. H. Thaler 2003 Can he Marke Add and Subrac? Msprcng n Tech Sock Carve-ous Journal of Polcal Economy 227-268. Mller E. 977 Rsk Uncerany and Dvergence of Opnon Journal of Fnance 32 5-68. 23
Pasor L. and R. F. Sambaugh 2003 Lqudy Rsk and Expeced Sock Reurn Journal of Polcal Economy 642-685. Sknner D. 989 Opons Markes and Socks Reurn Volaly Journal of Fnancal Economcs 23 6-78. Sefeddne A. and W. Wlhelm 996 An Emprcal Invesgaon of Shor-Sellng Acvy Pror o Seasoned Equy Offerngs Journal of Fnance 5 729-749. Senchack A. J. and L. T. Sarks 993 Shor-Sale Resrcons and Marke Reacon o Shor-Ineres Announcemens Journal of Fnancal and Quanave Analyss 28 77-94. Ross S. A. 976 Opons and Effcency Quarerly Journal of Economcs 90 75-89. Sulz René 999 Globalzaon Corporae Fnance and he Cos of Capal Journal of Appled Corporae Fnance 2 8-25. Woolrdge J. and A. Dcknson 994 Shor Sellng and Common Sock Prces Fnancal Analyss Journal 50 20-28. World Facbook. 2002 Cenral Inellgence Agency VA.. 24
Table I: Legaly and feasbly of shor-sellng Ths able repors survey daa on shor-sellng regulaons and feasbly from counres from he begnnng of he 20 h cenury hrough 2002 (some emporary changes n saus durng or before WWII were gnored). The fgures n Column 2 are he year shor-sellng became legal. The fgures n Column 3 are he year when shor-sellng became feasble. Yes means shor-sellng has always been legal or feasble. means shor-sellng has always been prohbed or no feasble. Deals abou shor-sellng rules and mplemenaon are n he las column. Counry Legaly Feasbly Deals Developed Markes Ausrala Yes Yes Ausra Yes Yes Belgum 935 935 Regulaons are no very explc. Shor-sellng s allowed and wdespread. Canada Yes Yes A emporary ban on shor-sellng was lfed n 0/40. Denmark Yes Yes The Copenhagen Sock Exchange's Rule Book does no carry any shorsellng resrcons. There had never had such resrcons n Denmark. Fnland 998 Tax laws (ransfer) nhbs would-be shor sellers. France Yes Yes Germany Yes Yes Hong Kong 994 994 Shor-sellng was prohbed unl /3/94. In 3/96 many resrcons were lfed (ncludng ck rule abolshed). On 9/7/98 more resrcons were placed (ncludng ck rule). The number of desgnaed secures for shor-sellng s revsed on a quarerly bass. Ireland Yes Yes resrcons. Ialy Yes Yes Japan Yes Yes Shor-sellng s regulaed by Arcle 62 of he Secures and Exchange Law. I s no resrced. Luxembourg 99 99 Crcular CSSF 9/75 allows shor-sellng. Neherlands Yes Yes New Zealand 992 Shor-sellng was allowed snce 4/92 for approved secures wh condoned on lqudy. Snce 7/00 all FASTER secures can be shored. However ax legslaon s unfavorable o shor-sellng. rway 992 999 Shor-sellng was allowed n 992. In 8/99-9/99 shor sellng rules and gudelnes nsued makng feasble. Porugal Yes Yes Sngapore Yes Secures lendng akes place ousde of he Island. Shor -sellng s dscouraged by regulaors however s wdespread. Span 992 Allowed n 992 bu no common. Sweden 993 993 Allowed snce 5/7/93. Swzerland Yes Yes The Swss exchange has never ssued any rules on shor-sellng. r dd s predecessors varous local exchanges n Zurch Geneva Basel ec. whch were floor based and n operaon unl 95/96. Uned Kngdom Yes Yes Uned Saes Yes Yes The U.S. sared prohbng shor sales on a down ck n 93. In 932 brokers were requred o oban wren auhorzaon from her clens before lendng shares. Currenly shor sales are allowed when he curren prce s hgher han he prce of he prevous rade (an upck) or when he curren prce s unchanged from he prevous rade bu hgher han he las rade a a dfferen prce (zero-plus ck). 25
Counry Legaly Feasbly Deals Emergng Markes Albana Argenna 999 Shor-sellng s no common for socks bu common for governmen bonds. Shor-sellngs may be held for up o 365 consecuve days. Mercado de Valores de Buenos Ares may suspend new shor sales a any momen. The law allowng shor-sellng was naced on 9/6/999. Armena Yes Allowed bu no feasble ye. Azerbajan Bahran Bangladesh Barbados Bermuda Bolva Boswana Brazl 986 Legal snce 6/9/86. CBLC (he exchange's clearng and selemen corporaon) has a secures cusody servce called Secures Lendng Program - BTC whch was mplemened n 4/96. However shorsellng s very lmed. Bulgara Chle 999 200 Bolsa de Sanago approved shor sellng rules allowng shor-sellng on. Shor-sellng was exemp from capal gans axaon and was more feasble afer /6/0. Chna Colomba Cosa Rca Croaa Cyprus Consdered a crmnal offence. Czech Republc Yes Yes regulaon prohbng shor-sellng. Shor sellng exss. Ecuador Egyp El Salvador Esona Yes regulaon resrcng shor-sellng. Bu here s no regulaon governng shor-sellng pracce. Fj 996 996 Par VII em 46 (4) of 996 ac allows shor-sellng and esablshes rules on shor-sellng pracce. Georga Ghana Greece 200 Shor sellng allowed n 5/3/0 bu no wdespread. Guaemala Honduras Hungary Yes regulaon resrcng shor-sellng. Bu here s no regulaon governng shor-sellng pracce. Iceland 986 Shor-sellng s uncommon. I s resrced for muual funds. Inda Yes Prohbed for foregn nvesors. real exsence. Indonesa Expeced o be launched n 7/03. Iran Israel Ivory Coas Jamaca Jordan Kazakhsan In he pure sae shor sellng a KASE s absen. They do no have a neng. Whn rade day he seller of he shares or bonds s oblged o confrm presence of secures on hs accoun. 26
Counry Legaly Feasbly Deals Emergng Markes Kenya Kuwa Kyrgysan Lava Lebanon Prohbed by arcle 82 of decree 7667 of 995 (Beru Bourse). Lhuana Macedona Malaw Yes Secures lendng s allowed n he marke bu no ye feasble. Malaysa Allowed n 995 prohbed n 997 Sared exsng n 996 sopped n 997 Shor-sellng sared on 9/30/96. The prohbon on 8/28/97 was a reacon o he Asan currency crss. Mala Legslaon s currenly beng drafed o allow secures lendng. Maurus Mexco Yes Yes Moldova Mongola Morocco Namba 992 Shor-sellng s allowed by arcle 24 of he Sock Exchange Conrol Ac. Ncaragua Ngera Oman Paksan Palesne Panama Paraguay Peru 2002 Phlppnes Prohbed n 989 allowed n 996 Shor-sellng was prohbed n 2/89. The revson of he rules n 996 lfed he prohbon. In 999 he Secures and Exchange Commsson approved he proposed PSE Rules ha would make shor-sellng more feasble. Is mplemenaon s sll pendng he passage of he Senae Commee Repor. 5: Elmnaon of Imposon of DST on he secondary radng of fnancal Insrumens. Poland 2000 WSE has no rules on shor-sellng. Shor-sellng s regulaed by a decree of counsel of mnsers; shor-sellng was frs allowed on //00. Romana Russa Yes Yes Always exsed; Shor-sellng was explcly regulaed snce 3/23/02. Saud Araba Slovaka Slovena Yes Shor sellng s no expressly allowed or prohbed a he momen bu changes n regulaon regardng hs maer are expeced. Souh Afrca Yes Yes 27
Counry Legaly Feasbly Deals Emergng Markes Souh Korea 996 Shor-sellng has been allowed snce 9/96. Bu shor-sellng s prohbed o nsders and avalable on desgnaed secures. Socks nelgble for shorsellng nclude socks under survellance and socks desgnaed as admnsrave ssues. Sr Lanka Sudan Swazland Prohbed snce 3/99 when he Swazland Sock Exchange was consued. Tawan 998 998 Regulaons allow shor-sellng snce 9/4/98. Bu he sho-sale prce mus be hgher or equal o prevous day's closng prce. Tanzana Thaland 998 200 0/98 rules and regulaons placed. Shor sellng s feasble snce //0. Trndad and Tobago Tunsa Turkey 995 995 4/3/95 Shor sellng allowed for socks on ISE Naonal 00. Ukrane Uruguay Uzbeksan Yes The legslaon does no prohb shor-sellng Bu here s no regulaory framework ha suppors shor-sellng. Invesors can lend/borrow secures drecly va deposary houses only. Venezuela Yugoslava Zamba Zmbabwe 28
Table II: Feasbly of pu opons radng Ths able repors survey daa on pu opons radng feasbly from counres from he begnnng of he 20 h cenury hrough 2002 (some emporary changes n saus durng or before WWII were gnored). The fgures n Column 2 are he year pu opons radng became feasble. Yes means pu opons radng has always been feasble. means pu opons radng has never been feasble. Deals abou pu opons radng are n he las column. Counry Feasbly Deals Developed Markes Ausrala 982 9/9/82. Ausra 99 8/0/9. Belgum 992 Opons on ndces and socks began radng on 6/2/92. Canada 975 Opons sared lsng on he Monreal Exchange on 9/5/75. Sared lsng on he Torono Exchange on 0//75. Denmark 990 European syle pu opons on fuures on he KFX share ndex sared radng snce 9/2/90. On 2/7/90 pu opons on ndvdual Dansh eques sared radng. On 3/8/9 pu opons on governmen bonds sared radng On 9/6/95. Pu Amercan opons on he KFX ndex sared radng n 2000. Fnland 988 Opons on he FOX ndex whch ncludes he 25 mos raded socks on he Helsnk Exchange sared on 5/2/88. France 987 Germany 990 Sared n /90 on ndvdual socks and n Augus on he DAX ndex. Hong Kong 993 Index opons sared radng on 3/5/93. Sock opons sared radng on 9/8/95. Ireland Ialy 995 Opon conracs on he MIB 30 sared radng on /5/95. Opons on some of he mos lqud ndvdual socks sared radng on 2/9/96. Japan 989 TOPIX Index pus sared radng n 0/20/89. Equy pus sared radng n 7/97. Luxembourg Neherlands 978 Opons on 3 lsed socks sared n 4/78. Shorly afer opons on 4 lsed socks sared radng. New Zealand rway 990 5/22/90. Porugal 999 Opon conracs are raded on SEND - Elecronc Dervaves Tradng Sysem. Sngapore 993 Opons marke relaunched on 3/8/93 followng an aborve aemp n 980 whch folded afer 2 years. Span 992 /4/92. Sweden 987 The OM Sockholm/OMLX London exchange nroduced opons on Swedsh socks on 6/2/87. Swzerland 988 Opons on ndvdual eques were frs lsed on SOFFEX on 5/9/88. Uned Kngdom 984 5/3/84. Uned Saes 973 The CBOE frs raded opons on 4/26/73. There were 9 conracs raded on 6 socks. 29
Counry Feasbly Deals Emergng Markes Albana Argenna 99 The rules were nroduced n 986 bu he frs ransacons were on 7/3/9. Armena Azerbajan Bahran Bangladesh Barbados Bermuda Bolva Boswana Brazl 984 Sock opons 2/8/84. Index opons 7/96. Bulgara Chle 994 Opons began radng n 8/94. Chna Colomba Cosa Rca Croaa Cyprus Czech Republc Ecuador Egyp El Salvador Esona 996 Traded from sprng 996; no regulaed opon marke wh cenral counerpary. Fj Georga Ghana Greece 2000 Pu opons on he FTSE/ASE-20 ndex sared radng on 9//00. Guaemala Honduras Hungary 2000 Opons radng began a BSE on 2/8/00. Iceland Inda 200 Opon radng nroduced on 7/2/0 afer he Kean Parekh Scam. Indonesa 2004 Sared on 0/6/04 wh 5 blue chp socks. Iran Israel 993 8//93. Ivory Coas Jamaca Jordan Kazakhsan Kenya Kuwa Kyrgysan Lava Lebanon Lhuana Macedona 30
Counry Feasbly Deals Emergng Markes Malaw Malaysa 2000 2//00. Mala Maurus Mexco Na Moldova Mongola Morocco Namba Ncaragua Ngera Oman Paksan Palesne Panama Paraguay Peru Phlppnes Poland 2000 Pu warrans raded snce /2/00. Romana Russa 200 FORTS has 2 pu opons on Uned Energy Sysem and Gazprom ha sared radng n 9/9/0. Opons have been radng on and off for 0 years unsuccessfully unl he above dae. Saud Araba Slovaka Slovena Souh Afrca 992 Souh Korea 997 Opon on KOSPI 200 began radng on 7/7/97 and sock opons for ndvdual frms began radng on /28/02. Sr Lanka Sudan Swazland Tawan Tanzana Thaland Trndad and Tobago Tunsa Turkey Ukrane Uruguay Uzbeksan 993 Small marke. Venezuela Yugoslava Zamba Zmbabwe 3
Table III: Summary sascs Varable name Mean Sandard Maxmum Mnmum devaon Skewness 0.0662 0.798 4.647-4.5862 Lagged derended urnover -0.008 0.5298 6.5629-2.6573 SSPO feasbly 0.4279 0.4948.0000 0.0000 Monhly Reurn 0.0076 0.0950.0229 -.24 Lberalzaon 0.586 0.4933.0000 0.0000 Volaly 0.0009 0.0050 0.995 0.0000 Turnover 0.0826 0.7494 26.093 0.0000 Volume Asymmery 0.0750 0.259.8500-2.403 Crash 0.0364 0.873.0000 0.0000 Cred rang 4.858 25.5882 98.9000 3.6000 32
Table IV: Shor-sellng and condonal skewness Ths able repors esmaes from panel regressons of monhly skewness on SSPO feasbly conrollng for lagged reurn lagged derended urnover lberalzaon a me rend and counry-fxed-effecs (no repored). The skewness measure s defned by equaon () n he ex. SSPO feasbly s a bnary varable ha equals one f eher shor-sellng or pu opon radng s feasble n ha counry durng ha monh. The ndcaor varable lberalzaon changes from zero o one n he monh afer he offcal lberalzaon dae. Lagged reurn s he ndex reurn durng he prevous monh. The varable lagged derended urnover s he one monh lag of he average over he prevous sx monhs of urnover afer s derended. The derendng s done by subracng from urnover he average of urnover durng he prevous egheen monhs. All regressons are correced for heeroskedascy and counry-specfc auocorrelaon. The p-value of each esmae s repored n parenhess. We selec counres wh changes n shor-sellng or pu opon radng evens. Panel B repors average skewness for hese counres before and afer he even monh. The averages are aken for 2-year and 5-year wndows. P-value ha ess he hypohess of no change s repored n parenheses. Panel A: Regressons Independen varables Lagged derended urnover SSPO feasbly 0.536 (0.25) 0.022 (0.4250) All counres Developed counres Emergng counres 0.0352 (0.2266) -0.8395 (0.930) -0.049 (0.723) -0.8375 (0.999) 0.0068 (0.8748) 0.774 (0.379) 0.0556 (0.464) 0.773 (0.388) 0.0552 (0.723) Lagged reurn -0.6376-0.640-0.6362-0.6434-0.6389-0.6388 Lberalzaon -0.0032 (0.8958) 0.023 (0.4644) -0.0085 (0.9007) 0.0268 (0.764) -0.05 (0.678) -0.03 (0.8403) Tme rend -0.006 (0.492) Panel B: Pre- and pos- even es Average skewness 2-year pre-even 0.09 2-year pos-even 0.298 Change 0.09 (0.6267) 5-year pre-even 0.29 5-year pos-even 0.389 Change 0.0 (0.8559) -0.006 (0.668) 0.000 (0.978) 33
Table V: Shor-sellng and condonal volaly Ths able repors esmaes from panel regressons of condonal volaly on SSPO feasbly conrollng for lberalzaon and a counry-fxed-effecs (no repored). Volaly of daly reurns s he sandard devaon of daly reurns compued each monh. Volaly of monhly reurns s compued usng he ARCH model gven n Equaon (3). SSPO feasbly s a bnary varable ha equals one f eher shor sellng or pu opon radng s possble. The ndcaor varable lberalzaon changes from zero o one n he monh afer he offcal lberalzaon dae. All regresson coeffcens are correced for heeroskedascy and counry-specfc auocorrelaon. The p-value of each esmae s repored n parenhess. Independen varables All counres Developed counres Emergng counres Varance Varance of Varance Varance of Varance Varance of of Daly monhly of Daly monhly of Daly monhly reurns reurns reurns reurns reurns reurns SSPO feasbly -0.004-0.0024 (0.0084) -0.0007 (0.035) -0.0002 (0.768) -0.002-0.0042 (0.0089) Lberalzaon -0.0004 (0.0250) -0.0009 (0.224) 0.0050 (0.0002) 0.0009 (0.006) -0.005 (0.0035) -0.0029 (0.0792) Tme rend 0.000 0.000 (0.43) 0.000 (0.05) -0.000 (0.232) 0.000 (0.0024) 0.0002 (0.0638) 34
Table VI: Shor-sellng and marke crash We couned as a crash observaon a monh wh a negave reurn larger han 2 sandard devaons where he sandard devaon of reurns s he average of sandard devaon of reurns durng he prevous hree monhs. crash = 0 f r < 2σ and crash = oherwse. The average sandard devaon σ ˆ ˆ ˆ = ( σ + σ 2 + σ 3)/3. Ths able repors esmaes of panel log regressons of crash on SSPO feasbly conrollng for lberalzaon and counry-fxed-effecs (no repored). SSPO feasbly s a bnary varable ha equals one f eher shor-sellng or pu opon radng s possble. The ndcaor varable lberalzaon changes from zero o one n he monh afer he offcal lberalzaon dae whch was obaned from Bekaer and Harvey (2000). All regressons are correced for heeroskedascy and counry-specfc auocorrelaon. The p-value of each esmae s repored n parenhess. All counres Developed counres Emergng counres SSPO feasbly -0.0383 (0.7375) Lberalzaon -0.096 (0.934) -0.0220 (0.920) -0.8302 (0.0375) 0.240 (0.4665) 0.3094 (0.2375) 35
Table VII: Shor-sellng and lqudy Ths able repors esmaes from panel regressons of he logarhm of urnover on SSPO feasbly conrollng for lagged absolue reurn lagged volaly lberalzaon a me rend and counry-fxedeffecs (no repored). Turnover s defned as he naural logarhm of he rao of volume of dollar rade per monh o dollar marke capalzaon a he end of he monh. SSPO feasbly s a bnary varable ha equals one f eher shor-sellng or pu opon radng s possble. Lagged absolue reurn s he absolue value of ndex reurn durng he prevous monh. Lagged volaly s he sandard devaon of daly reurns durng he prevous monh. The ndcaor varable lberalzaon changes from zero o one n he monh afer he offcal lberalzaon dae whch was obaned from Bekaer and Harvey (2000). All regressons are correced for heeroskedascy and counry-specfc auocorrelaon. The p-value of each esmae s repored n parenhess. Independen varables All counres Developed counres Emergng counres SSPO feasbly 0.5676 0.6557 0.3422 0.7345 0.9096 0.3232 (0.0005) 0.3996 0.4282 0.3775 Lagged absolue reurn 0.8086 (0.0002) 0.83 (0.000) -0.0238 (0.9586) 0.4529 (0.296).0850.0699 Lagged volaly 3.966 (0.0005) 2.583 (0.0027) 5.372 (0.890).0598 (0.7676) 3.2470 (0.0008) 3.25 (0.000) Lberalzaon 0.29 (0.055) 0.053 (0.2707) -0.5257-0.485 (0.575) -0.676 (0.595) -.48 0.93 (0.0004) 0.336 (0.0040) -0.0324 (0.763) Tme rend 0.0374 0.0429 0.006 (0.0246) 36
Table VIII: Shor-sellng and volume asymmery Monhly volume asymmery for counry s defned as: VA = n τ n Vol τ D Vol ( ) D τ τ τ τ n n D ( D ) τ τ τ n τ Vol n τ τ where Vol s he daly dollar volume for day τ n monh D τ τ s a dummy varable ha akes on value f he reurn on day τ s posve and 0 f s negave; and n s he number of daly observaons n monh. Ths able repors esmaes from panel regressons of volume asymmery (VA) on SSPO feasbly a crash varable and an neracon erm crash x SSPO feasbly conrollng for lberalzaon and counry-fxed-effecs (no repored). Crash s one for a monh wh a negave reurn larger han 2 sandard devaons where he sandard devaon of reurns s he average of sandard devaon of reurns durng he prevous hree monhs. SSPO feasbly s a bnary varable ha equals one f eher shor-sellng or pu opon radng s possble. The ndcaor varable lberalzaon changes from zero o one n he monh afer he offcal lberalzaon dae whch was obaned from Bekaer and Harvey (2000). All regressons are correced for heeroskedascy and counry-specfc auocorrelaon. The p- value of each esmae s repored n parenhess. Independen varables All counres Developed counres Emergng counres SSPO feasbly -0.027 (0.75) -0.02 (0.963) -0.04 (0.008) -0.0425 (0.004) 0.027 (0.3366) 0.049 (0.255) Crash -0.0733 (0.047) -0.095 (0.2004) -0.0689 (0.0942) SSPO feasbly Crash -0.0070 (0.8580) 0.0279 (0.738) -0.0436 (0.423) Lberalzaon -0.0034 (0.74) -0.0033 (0.722) 0.0076 (0.7869) 0.0079 (0.7802) -0.008 (0.2984) -0.00 (0.2877) 37
Table IX: Shor-sellng and cos of capal: an even sudy We colleced 3 specfc daes when an exchange sared allowng shor sellng or pu opon radng. We use he perods from -30 days o -30 days and from +30 days o +30 days o esmae he world marke model whch s used o calculae he abnormal reurns durng he even wndow. Ths able repors abnormal reurns and cumulave abnormal reurns (CAR) from 5 days before he even dae o 5 days afer he even dae. The las row provdes he -sasc assocaed wh he -day CAR usng he mehodology proposed by Brown and Warner (985). Shor-sellng & pu opons Shor-sellng only Pu opons only Even dae Abnormal reurn CAR Abnormal reurn CAR Abnormal reurn CAR -5 0.408 0.408 0.8 0.8 0.472 0.472-4 0.773.8-0.960-0.779.268.74-3 0.85.366-0.439 -.28 0.363 2.03-2 0.322.688.42-0.076 0.00 2.04-0.254.942-0.875-0.95 0.576 2.68 0 0.295 2.237 2.269.38-0.269 2.4 0.32 2.369.583 2.90-0.282 2.29 2 0.364 2.733 0.543 3.444 0.34 2.443 3 0.709 3.442.77 5.25 0.405 2.848 4 0.83 3.625.553 6.768-0.208 2.64 5-0.00 3.624.259 8.027-0.465 2.75 T-sas 2.506 3.090.28 38
Table X: Shor-sellng and cos of capal: usng equy reurn as he cos of capal Panel A repors he coeffcen esmaes of he followng nernaonal asse prcng model: ( + φ ) λvarh e r rf = 0 + φ λcovh w + + α where λ he esmaed prce of he covarance rsk wh he world and cov λ s he esmaed prce of var v own counry varance rsk. r rf s he monhly equy reurn for each counry mnus he one monh U.S. T-Bll reurn. The ndependen varable h w s he condonal covarance and h s he condonal varance obaned from he mulvarae ARCH model n equaon (3). The ndependen varable φ measures he level of negraon of counry a me and s defned n equaon (6). Panel B repors he coeffcens from he esmae of he followng model wh counry-fxed-effecs (no repored): e =ψ 0 + ψ SSPO Feasbly +ψ 2 Foregn Exchange Rsk + ψ 3 Lberalzaon + v where e s from he above asse prcng model. SSPO feasbly s a bnary varable ha equals one f eher shor-sellng or pu opon radng s possble. Foregn exchange rsk s esmaed from he mulvarae ARCH model n (3). The ndcaor varable lberalzaon changes from zero o one n he monh afer he offcal lberalzaon dae whch was obaned from Bekaer and Harvey (2000). Panel A: Esmaes of he nernaonal asse prcng model Dependen varable Excess reurn of counry Some ndependen varables Covarance of counry s equy reurn wh world equy reurn mulpled by measure of he counry s negraon wh he world Varance of he counry s equy reurn mulpled by one mnus measure of counry s negraon wh he world λ cov = 5.0457 (0.003) λ var = 2.4667 (0.0727) Panel B: Panel regresson esmaes Dependen varable Resdual from rsk adjusmen model ( e ) Independen varables All counres Developed counres Emergng counres SSPO feasbly -0.007 (0.3997) Foregn exchange rsk h fx 0.585 (0.3479) Lberalzaon -0.0049 (0.0444) -0.0024 (0.3254) 0.546 (0.8077) 0.002 (0.666) -0.0036 (0.3673) 0.233 (0.5657) -0.006 (0.080) 39
Table XI: Shor-sellng and cos of capal: usng cred rangs as he cos of capal The panel regressons wh counry-fxed effecs are based on bannual daa from 979:2 hrough 2002:2. The dependen varable s cred rang whch represens he naural logarhm of a counry cred rang. Counry cred rangs are obaned from Insuonal Invesor s sem-annual survey of 75 o 00 bankers. Respondens rae each counry on a scale of 0 o 00. SSPO feasbly s a bnary varable ha equals one f eher shor-sellng or pu opon radng s possble. The ndcaor varable lberalzaon changes from zero o one n he monh afer he offcal lberalzaon dae whch was obaned from Bekaer and Harvey (2000). P-values are n parenheses. We correc for counry-specfc heeroskedascy and counry-specfc auocorrelaon. Dependen varable Cred rang Independen varables All counres Developed counres Emergng counres SSPO feasbly 0.03 (0.0002) Lberalzaon 0.0457 (0.0640) 0.029 (0.0695) 0.753 (0.003) 0.659 (0.0007) 0.0277 (0.299) 40
Fgure. Shor Sellng Regulaons & Pu Opons n he Tweneh Cenury 200 80 60 40 20 00 Number of counres n he world Number of counres wh sock marke Number of counres allowng shor sellng Number of counres where shor sellng exss Number of counres wh pu opons 80 60 40 20 0 900 905 90 95 920 925 930 935 940 945 950 955 960 965 970 975 980 985 990 995 2000 4
Fgure 2: Cumulave abnormal reurn a he even dae when counres frs allow shor-sellng 6.4 5.6 4.8 Cumulave abnormal reurns 4.0 3.2 2.4.6 0.8 0.0-0.8-20 -5-0 -5 0 5 0 5 20 Days 42