The Impact of the 2011 Short‐Sale Ban on Financial Stability: Evidence from the Spanish Stock Market

• Author: Sergio Mayordomo,Óscar Arce
• Published date: 01 November 2016
• DOI: http://doi.org/10.1111/eufm.12085
• Date: 01 November 2016

The Impact of the 2011 Short-Sale Ban

on Financial Stability: Evidence from

the Spanish Stock Market



Oscar Arce

Banco de Espa~

na, DG Economics and Statistics, Calle Alcal

a 48, 28014, Madrid, Spain

E-mail: o.arce@bde.es

Sergio Mayordomo

School of Economics and Business, University of Navarra, Edificio Amigos, 31009 Pamplona, Spain

E-mail: smayordomo@unav.es

ABSTRACT

We examine the effect of the 2011 short-selling ban on Spanish stocks on the

financial sector’s risk level. Before the ban, short positions were positive and

significantly related to several indicators of bank default risk. Subsequently, the

ban moderated the risk of banking institutions, especially those more exposed to

short-seller activity, which, on average, showed higher levels of maturity

mismatch, uncertainty about their fundamentals, and exposure to sovereign risk.

The ban also caused a side effect on non-financial firms, since it led to an increase

in their exposure to short sales, reflecting the existence of a common aggregate risk

factor.

Keywords: short-sales constraints, financial stability, financial institutions, credit

default swap, contagion

JEL classification: G01, G12, G14, G18

The authors would like to thank John Doukas (the Editor), an anonymous referee, Ricardo

Gimeno, Ana Gonz

alez, 

I~

nigo de la Lastra, German Lopez-Espinosa, David Marqu

es-

Ib

a~

nez, Melissa Porras, Stefano Puddu, Fernando Restoy, Diego Rodr

ıguez-Palenzuela,

Mar

ıa Rodr

ıguez-Moreno, Pedro Saffi, Lucio Sanju

an, Rafael Santamar



ıa, Peter Sinclair,

Kumar Venkataraman and other participants at the Second CNMV International

Conference on Securities Markets, the XX Finance Forum, the 2013 ESCB Day-Ahead

Conference (Bank of England), the 2014 World Finance Conference (Venice), and Goethe

University, Public University of Navarra and University of Neuchatel seminars. Sergio

Mayordomo acknowledges financial support from MCI grant ECO2012-32554. This paper

was previously circulated under the title ‘Short-sale Constraints and Financial Stability:

Evidence from the Spanish Market’. The opinions in this article are the sole responsibility

of the authors and they do not necessarily coincide with those of the Banco de Espa~

na.

European Financial Management, Vol. 22, No. 5, 2016, 1001–1022

doi: 10.1111/eufm.12085

© 2016 John Wiley & Sons, Ltd.

1. Introduction

On 11 August 2011, the supervisors of four European countries (Belgium, France, Italy

and Spain) announced a ban on establishing or increasing short positions in financial

institutions’stocks. This measure was adopted at a time of heightened aggregate

uncertainty and volatility in financial markets that coincided with the resurgence of

tensions in the sovereign debt markets of various euro area countries.

The Spanish regulator (Comisi

on Nacional del Mercado de Valores, or CNMV), in its

own communication enacting the ban, argued that the extreme volatility then affecting

European securities markets in general and bank sector stocks in particular was posing a

material threat to the stability and orderly functioning of markets. Therefore,

safeguarding financial stability was the leading motive behind the decision to

temporarily prohibit short positions in the shares of 16 Spanish financial corporations.

1

Although there is an extensive literature that analyses the effect of short-sale bans on

market performance, including the impact of the ban on liquidity, stock prices and price

discovery,

2

little is known about the impact of restrictions on short positions on the

stability of the financial sector. We analyse the implications of the ban imposed by the

Spanish regulator in terms of financial stability, which we proxy by means of indicators

of bank default risk, including model-based default probabilities and prices of credit

default swaps (CDSs).

As a preliminary step, we offer evidence of a positive relationship between short positions

and the default risk indicators of banks in the weeks preceding the ban. Subsequently, the

ban contributed to a significantmoderation of thedefault risk of banks relativeto that of non-

financial firms, whose risk indicators were unaffected by the short sales prohibition.

Specifically, the ban was significantly effective in reducingthe default probability of banks

on whose capital short sellers had accumulated higher positions prior to the ban.

But why were some firms shorted more aggressivelythan others? The potential linkage

between the short selling of financial stocks and banking stability has recently been

explored from a theoretical standpoint in several articles. Brunnermeier and Oehmke

(2014) explore a setting where short-term creditors impose leverage constraints on

financial institutions. Then, when a firm is sufficiently close to such constraints, by

aggressively short-selling its stock, short sellers can force its liquidation. In some cases,

this outcome may coexistwith a high-valuation equilibrium in which liquidationand short

sales do not take place.Hence, the authors conclude that temporary restrictionson the short

selling of stocks from vulnerable institutions may be justified to avoid inefficient

liquidations.Though based on different grounds,a similar policy recommendation follows

from the analyses of Brunnermeier and Pedersen (2005) and Venter (2011).

Liu (2015) examines a different channel through which the short sales of a bank’s

stock can cause its failure. At the core of the mechanism is the idea that creditors, who

1

The firms affected by the ban were Banca C

ıvica, Banco Bilbao Vizcaya Argentaria, Banco

de Sabadell, Banco de Valencia, Banco Espa~

nol de Cr

edito, Banco Pastor, Banco Popular

Espa~

nol, Banco Santander, Bankia, Bankinter, Caixabank, Caja de Ahorros del

Mediterr

aneo, Grupo Catalana de Occidente, Mapfre, Bolsas y Mercados Espa~

noles and

Renta 4 Servicios de Inversi

on.

2

See, for example, Beber and Pagano (2013), Boehmer et al. (2013), Boehmer and Wu

(2013), Bris et al. (2007), Marsh and Payne (2012) and Saffiand Sigurdsson (2011).

© 2016 John Wiley & Sons, Ltd.

1002 

Oscar Arce and Sergio Mayordomo