DOCSLIB.ORG

The Effectiveness of Short-Selling Bans

Total Page：16

File Type：pdf, Size：1020Kb

Download full-text PDF Read full-text
The Effectiveness of Short-Selling Bans An Academic View: The Effectiveness of Short-Selling Bans Travis Whitmore Securities Finance Research, State Street Associates Introduction As the COVID-19 virus continues At the same time, regulators have reacted to tighten its grip on the by stiffening regulations to try and protect markets from further price declines. One such world – causing wide spread response, which is common during periods lockdowns and large-scale of financial turmoil, has been to impose disruptions to global supply chains short-selling bans. At the time of writing this, short-selling bans have been implemented in – governments, central banks, and seven countries with potentially more following regulators have been left with little suit. South Korea banned short selling in three choice but to intervene in financial markets, including its benchmark Kospi Index, markets. Central banks have for six months. As stock markets plunged across Europe in late March, Italy, Spain, already pulled out all the stops. France, Greece, and Belgium temporarily halted short selling on hundreds The US Federal Reserve slashed interest of stocks.2 rates to near zero and injected vast amounts of liquidity into the financial system with In this editorial, we discuss the impact “a $300 billion credit program for employers” of short-selling bans on markets and if it and “an open-ended commitment” of will be effective in stemming asset price quantitative easing, meaning unlimited declines resulting from the economic fallout buy back of treasuries and investment from COVID-19. To form an objective view, grade corporate debt. Governments have we review empirical findings from past started to pull on the fiscal policy lever academic studies and look to historical as well, approving expansive stimulus event studies of short-selling bans. packages to bolster faltering economies.1 2 Key questions 1 Why are short-selling bans implemented? Regulators implement short-selling restrictions during periods of market stress in an effort to reduce volatility and prevent further declines in asset prices. Are short-selling bans effective in stemming price declines? 2 When viewed holistically, empirical evidence suggests short- selling bans do not prevent declines in asset prices or reduce volatility but instead degrade market quality. Should regulators impose short-selling bans in the wake of COVID-19? 3 In a view formed purely by empirical evidence, short-selling bans in the wake of the fallout caused by COVID-19 may do more harm than good. 3 Why are bans on short selling common during market down turns? This is not the first-time regulators The controversial nature of short-selling have resorted to bans on short restrictions, the availability of extensive data, and the numerous event studies that selling during periods of financial demonstrate the impact that temporary distress, as shown in Figure 1. bans cause, has long garnered the interest of academics and resulted in a large body Short selling has historically faced scrutiny, of work. These studies provide empirically especially during market downturns. At the based evidence and important insights that height of the 2008 financial crisis, the SEC help us understand the effectiveness of pointed to short selling as a driver behind the short-selling bans in stabilizing markets. sharp decline in financial stock prices saying bans will “protect the integrity and quality of the securities market and strengthen investor confidence”.3 When the market is under stress, regulators often say that these measures are necessary to reduce market volatility and prevent further declines in asset prices. Figure 1: Brief History of Short-Selling Regulations SEC reduce Greek debt crisis- NYSE imposes naked shorts with short selling banned restrictions on shorting approval of SHO across EU 1917 2004 2011 1938 2008 2020 SEC implements Emergency order by SEC Economic fallout from uptick rule (only stocks and European regulators COVID-19 results in with rising prices ban short selling bans on short selling can be shorted) Source: Wahba, P. and Chasan, E (2008). FACTBOX: Milestones in short-selling history. Thomson Reuters. 4 How do we study the impact of short selling and the restrictions there of? Before diving into academic sectional analyses which use daily or intra-day findings, it is helpful to understand stock-loan data to examine the impact of shorting flow. Each research methodology the different types of studies that provides a different perspective on the explore short selling’s role in securities lending market and short selling. capital markets. Empirical studies tend to fall into three main categories: (1) cross-country variation which leverage differences in regulations and market practices across countries, (2) event studies that analyze various historical events (e.g. short-selling bans in 2008), and (3) time-series and cross- 5 6 What does empirical evidence suggest about the effectiveness of short-selling bans? There are several event studies There are several studies that have shown that examine the short-selling bans short sellers to be informed market participants – increases in borrowing rates or during the 2008 financial crisis. shorting demand are correlated with abnormal negative returns.7,8 The evidence from these One of the most extensive studies, Beber studies suggest short sellers are informed in and Pagano (2013), analyzed 30 countries that they anticipate fundamental declines in during the financial crisis. The study, which prices and that they are important in efficient was published in the Journal of Finance, prices, which we get into more detail later. found no statistical difference in excess returns of stocks for which short sales were While there is some empirical evidence banned and those stocks in which short that suggest bans are effective, the weight selling was permitted, excluding U.S. stocks of it is in favor of bans having a limited (due to the approval of TARP). In their own impact on curbing price declines. words, short-selling bans were “at best neutral in its effects on stock prices”.4 A paper published by the Federal Reserve Bank of New York found “banning short selling does not appear to prevent stock prices from falling”, but instead “lowered market liquidity and increased trading costs”.5 Additional empirical evidence in a working paper from the European Systematic Risk Board agree with the findings above while also suggesting that stocks targeted by short-selling bans had increased volatility and probability of default.6 7 How do short-selling constraints impact capital markets? In addition to the weight of proxy for liquidity, was 15% higher. That empirical evidence suggesting is, there is increased liquidity of market indices when short selling is possible.9 that short-selling bans have limited impact on stemming price 2. Event studies: Financial stocks subject declines, existing studies also to shorting bans during the 2008 financial crisis resulted in spreads that were 200- suggest that these measures have 300% wider when controlling for previous unintended side effects on overall behavior, as shown in Figure 2.10,11,12 market quality. 3. Time-series: Suggest that short sellers can be liquidity suppliers when To help understand what these are, we spreads are especially wide, providing a review the role that short-selling plays in stabilizing force in the stock market.13 capital markets through two primary market functions: liquidity and price discovery. Price discovery Liquidity Price discovery is a critical process in financial markets in which the proper price of an asset Liquidity is the ease with which an asset is determined based on the incorporation of can be sold or bought and is commonly all available public information. Empirical proxied for by the bid-ask spread. In illiquid evidence from the three categories suggests markets bid-ask spreads are wider resulting that short-selling constraints restrict traders in costlier trades. Empirical findings with negative information from expressing from all three types of academic studies their sentiment, slowing the speed with which mentioned earlier tend to agree that short- news is incorporated into market prices. selling constraints reduce liquidity at the single-stock and broader market level. Listed below are several findings from various studies: Unintended consequences of short-selling restrictions are costlier trades that 1. Cross-county variation: An analysis of are more difficult to execute. Findings forty-six equity markets reveals that in from various types of studies: countries that permit short selling, stock- level prices incorporate information quicker 1. Cross-county variation: A study of 111 (as measured by the lack of synchronous countries found that in countries where movement in weekly returns).14 short selling is more feasible, turnover, a 8 2. Event studies: Price discovery was slower measures have little to no effectiveness in for stocks impacted by the short-selling bans preventing price declines, instead resulting during the 2008 financial crisis, especially in a degradation of market quality at a time where negative news was concernced.15 when it is most crucial. Short-selling bans have been imposed throughout Europe and 3. Time-series: Prices of stocks with short- Asia in response to the economic fallout selling constraints (such as low lending from COVID-19, but it is unlikely that similar supply) are less informative. Evidence bans will be put in place by US regulators also suggests increased “shorting flow given the
Load more

Recommended publications
  • Analysis of Securitized Asset Liquidity June 2017 an He and Bruce Mizrach1
    Analysis of Securitized Asset Liquidity June 2017 An He and Bruce Mizrach1 1. Introduction This research note extends our prior analysis2 of corporate bond liquidity to the structured products markets. We analyze data from the TRACE3 system, which began collecting secondary market trading activity on structured products in 2011. We explore two general categories of structured products: (1) real estate securities, including mortgage-backed securities in residential housing (MBS) and commercial building (CMBS), collateralized mortgage products (CMO) and to-be-announced forward mortgages (TBA); and (2) asset-backed securities (ABS) in credit cards, autos, student loans and other miscellaneous categories. Consistent with others,4 we find that the new issue market for securitized assets decreased sharply after the financial crisis and has not yet rebounded to pre-crisis levels. Issuance is below 2007 levels in CMBS, CMOs and ABS. MBS issuance had recovered by 2012 but has declined over the last four years. By contrast, 2016 issuance in the corporate bond market was at a record high for the fifth consecutive year, exceeding $1.5 trillion. Consistent with the new issue volume decline, the median age of securities being traded in non-agency CMO are more than ten years old. In student loans, the average security is over seven years old. Over the last four years, secondary market trading volumes in CMOs and TBA are down from 14 to 27%. Overall ABS volumes are down 16%. Student loan and other miscellaneous ABS declines balance increases in automobiles and credit cards. By contrast, daily trading volume in the most active corporate bonds is up nearly 28%.
    [Show full text]
  • The Professional Obligations of Securities Brokers Under Federal Law: an Antidote for Bubbles?
    Loyola University Chicago, School of Law LAW eCommons Faculty Publications & Other Works 2002 The rP ofessional Obligations of Securities Brokers Under Federal Law: An Antidote for Bubbles? Steven A. Ramirez Loyola University Chicago, School of Law, [email protected] Follow this and additional works at: http://lawecommons.luc.edu/facpubs Part of the Securities Law Commons Recommended Citation Ramirez, Steven, The rP ofessional Obligations of Securities Brokers Under Federal Law: An Antidote for Bubbles? 70 U. Cin. L. Rev. 527 (2002) This Article is brought to you for free and open access by LAW eCommons. It has been accepted for inclusion in Faculty Publications & Other Works by an authorized administrator of LAW eCommons. For more information, please contact [email protected]. THE PROFESSIONAL OBLIGATIONS OF SECURITIES BROKERS UNDER FEDERAL LAW: AN ANTIDOTE FOR BUBBLES? Steven A. Ramirez* I. INTRODUCTION In the wake of the stock market crash of 1929 and the ensuing Great Depression, President Franklin D. Roosevelt proposed legislation specifically designed to extend greater protection to the investing public and to elevate business practices within the securities brokerage industry.' This legislative initiative ultimately gave birth to the Securities Exchange Act of 1934 (the '34 Act).' The '34 Act represented the first large scale regulation of the nation's public securities markets. Up until that time, the securities brokerage industry4 had been left to regulate itself (through various private stock exchanges). This system of * Professor of Law, Washburn University School of Law. Professor William Rich caused me to write this Article by arranging a Faculty Scholarship Forum at Washburn University in the'Spring of 2001 and asking me to participate.
    [Show full text]
  • High-Frequency Trading and the Flash Crash: Structural Weaknesses in the Securities Markets and Proposed Regulatory Responses Ian Poirier
    Hastings Business Law Journal Volume 8 Article 5 Number 2 Summer 2012 Summer 1-1-2012 High-Frequency Trading and the Flash Crash: Structural Weaknesses in the Securities Markets and Proposed Regulatory Responses Ian Poirier Follow this and additional works at: https://repository.uchastings.edu/ hastings_business_law_journal Part of the Business Organizations Law Commons Recommended Citation Ian Poirier, High-Frequency Trading and the Flash Crash: Structural Weaknesses in the Securities Markets and Proposed Regulatory Responses, 8 Hastings Bus. L.J. 445 (2012). Available at: https://repository.uchastings.edu/hastings_business_law_journal/vol8/iss2/5 This Note is brought to you for free and open access by the Law Journals at UC Hastings Scholarship Repository. It has been accepted for inclusion in Hastings Business Law Journal by an authorized editor of UC Hastings Scholarship Repository. For more information, please contact [email protected]. High-Frequency Trading and the Flash Crash: Structural Weaknesses in the Securities Markets and Proposed Regulatory Responses Ian Poirier* I. INTRODUCTION On May 6th, 2010, a single trader in Kansas City was either lazy or sloppy in executing a large trade on the E-Mini futures market.1 Twenty minutes later, the broad U.S. securities markets were down almost a trillion dollars, losing at their lowest point more than nine percent of their value.2 Certain stocks lost nearly all of their value from just minutes before.3 Faced with the blistering pace of the decline, many market participants opted to cease trading entirely, including both human traders and High Frequency Trading (“HFT”) programs.4 This withdrawal of liquidity5 accelerated the crash, as fewer buyers were able to absorb the rapid-fire selling pressure of the HFT programs.6 Within two hours, prices were back * J.D.
    [Show full text]
  • Speculation in the United States Government Securities Market
    Authorized for public release by the FOMC Secretariat on 2/25/2020 Se t m e 1, 958 p e b r 1 1 To Members of the Federal Open Market Committee and Presidents of Federal Reserve Banks not presently serving on the Federal Open Market Committee From R. G. Rouse, Manager, System Open Market Account Attached for your information is a copy of a confidential memorandum we have prepared at this Bank on speculation in the United States Government securities market. Authorized for public release by the FOMC Secretariat on 2/25/2020 C O N F I D E N T I AL -- (F.R.) SPECULATION IN THE UNITED STATES GOVERNMENT SECURITIES MARKET 1957 - 1958* MARKET DEVELOPMENTS Starting late in 1957 and carrying through the middle of August 1958, the United States Government securities market was subjected to a vast amount of speculative buying and liquidation. This speculation was damaging to mar- ket confidence,to the Treasury's debt management operations, and to the Federal Reserve System's open market operations. The experience warrants close scrutiny by all interested parties with a view to developing means of preventing recurrences. The following history of market events is presented in some detail to show fully the significance and continuous effects of the situation as it unfolded. With the decline in business activity and the emergence of easier Federal Reserve credit and monetary policy in October and November 1957, most market elements expected lower interest rates and higher prices for United States Government securities. There was a rapid market adjustment to these expectations.
    [Show full text]
  • The Structure of the Securities Market–Past and Future, 41 Fordham L
    University of California, Hastings College of the Law UC Hastings Scholarship Repository Faculty Scholarship 1972 The trS ucture of the Securities Market–Past and Future William K.S. Wang UC Hastings College of the Law, [email protected] Thomas A. Russo Follow this and additional works at: http://repository.uchastings.edu/faculty_scholarship Part of the Securities Law Commons Recommended Citation William K.S. Wang and Thomas A. Russo, The Structure of the Securities Market–Past and Future, 41 Fordham L. Rev. 1 (1972). Available at: http://repository.uchastings.edu/faculty_scholarship/773 This Article is brought to you for free and open access by UC Hastings Scholarship Repository. It has been accepted for inclusion in Faculty Scholarship by an authorized administrator of UC Hastings Scholarship Repository. For more information, please contact [email protected]. Faculty Publications UC Hastings College of the Law Library Wang William Author: William K.S. Wang Source: Fordham Law Review Citation: 41 Fordham L. Rev. 1 (1972). Title: The Structure of the Securities Market — Past and Future Originally published in FORDHAM LAW REVIEW. This article is reprinted with permission from FORDHAM LAW REVIEW and Fordham University School of Law. THE STRUCTURE OF THE SECURITIES MARIET-PAST AND FUTURE THOMAS A. RUSSO AND WILLIAM K. S. WANG* I. INTRODUCTION ITHE securities industry today faces numerous changes that may dra- matically alter its methods of doing business. The traditional domi- nance of the New York Stock Exchange' has been challenged by new markets and new market systems, and to some extent by the determina- tion of Congress and the SEC to make the securities industry more effi- cient and more responsive to the needs of the general public.
    [Show full text]
  • The Actual Problems of Assets Securitization in Commercial Organizations
    ISSN 0798 1015 HOME Revista ESPACIOS ! ÍNDICES ! A LOS AUTORES ! Vol. 39 (Nº22) Year 2018. Page 28 The Actual Problems of Assets Securitization in Commercial Organizations Los problemas actuales de titulación de activos en organizaciones comerciales Tatiana M. KOVALEVA 1; Oleg A. KHVOSTENKO 2; Alla G. GLUKHOVA 3; Evgeny V. MOZHAROVSKY 4 Received: 03/02/2018 • Approved: 02/03/2018 Contents 1. Introduction 2. Methodology 3. Results 4. Conclusions Bibliographic references ABSTRACT: RESUMEN: The goal of the article is to develop theoretical El objetivo del artículo es desarrollar disposiciones provisions of assets securitization in the Russian teóricas de titulización de activos en la Federación de Federation, to analyze the problems and prospects of Rusia, para analizar los problemas y las perspectivas its development. The main result of the research is de su desarrollo. El principal resultado de la the development of suggestions for expansion of the investigación es el desarrollo de sugerencias para la objects of securitized assets through the mechanisms expansión de los objetos de los activos titulizados a of securitization of income from personal income tax. través de los mecanismos de titulización de los Keywords: securitization, financial risks, personal ingresos del impuesto a la renta personal. income tax, risk management Palabras clave: titulización, riesgos financieros, impuesto a la renta personal, gestión de riesgos 1. Introduction 1.1. Establishing a context During the last ten years the financial market of the Russian Federation has changed a lot as far as the formation of different financial instruments aimed at improving efficiency is concerned. Securitization of assets has occupied an important position among the instruments of financing.
    [Show full text]
  • Sudden Stops and Currency Crises: the Periphery in the Classical Gold Standard
    Sudden Stops and Currency Crises: The Periphery in the Classical Gold Standard Luis Catão* Research Department International Monetary Fund First Draft: November 2004 Abstract While the pre-1914 gold standard is typically viewed as a successful system of fixed exchange rates, several countries in the system’s periphery experienced dramatic exchange rate adjustments. This paper relates the phenomenon to a combination of sudden stops in international capital flows with domestic financial imperfections that heightened the pro-cyclicality of the monetary transmission mechanism. It is shown that while all net capital importers during the period occasionally faced such “sudden stops”, the higher elasticity of monetary expansion to capital inflows and disincentives to reserve accumulation in a subset of these countries made them more prone to currency crashes. JEL Classification: E44, F31, F34 Keywords: Gold Standard, Exchange Rates, International Capital Flows, Currency Crises. ___________________ * Author’s address: Research Department, International Monetary Fund, 700 19th street, Washington DC 20431. Email: [email protected]. I thank George Kostelenos, Pedro Lains, Agustín Llona, Leandro Prados, Irving Stone, Gail Triner, and Jeffrey Williamson for kindly sharing with me their unpublished data. The views expressed here are the author’s alone and do not necessarily represent those of the IMF. - 2 - I. Introduction The pre-1914 gold standard is often depicted as a singularly successful international system in that it managed to reconcile parity stability among main international currencies with both rapid and differential growth across nations and unprecedented capital market integration. Nevertheless, several countries in the periphery of the system experienced dramatic bouts of currency instability.
    [Show full text]
  • Brokerage, Market Fragmentation, and Securities Market Regulation
    This PDF is a selection from an out-of-print volume from the National Bureau of Economic Research Volume Title: The Industrial Organization and Regulation of the Securities Industry Volume Author/Editor: Andrew W. Lo, editor Volume Publisher: University of Chicago Press Volume ISBN: 0-226-48847-0 Volume URL: http://www.nber.org/books/lo__96-1 Conference Date: January 19-22, 1994 Publication Date: January 1996 Chapter Title: Brokerage, Market Fragmentation, and Securities Market Regulation Chapter Author: Kathleen Hagerty, Robert L. McDonald Chapter URL: http://www.nber.org/chapters/c8101 Chapter pages in book: (p. 35 - 62) 2 Brokerage, Market Fragmentation, and Securities Market Regulation Kathleen Hagerty and Robert L. McDonald 2.1 Introduction A striking fact about the organization of modem financial markets-and one of the great interest to market regulators and exchanges-is the prevalence of market fragmentation, that is, multiple mechanisms or locations for trading a security. A share of common stock, for example, may be traded on one of many organized exchanges, through dealers away from an exchange, in another country, or indirectly through a derivative financial contract, which in turn may be traded on an exchange or through a dealer. To the extent that securities markets provide a central trading location serv- ing to minimize the search cost of finding a counterparty, fragmentation is a puzzle. On the other hand, market participants often have private information, either about the “true value” of the traded security, or about their trading mo- tives.’ In markets with asymmetric information, informed traders earn a profit at the expense of the uninformed traders2 Therefore there is clearly an incen- tive to create mechanisms that mitigate (for at least some subset of partici- pants) costs created by the existence of private information.
    [Show full text]
  • The Flash Crash: the Impact of High Frequency Trading on an Electronic Market∗
    The Flash Crash: The Impact of High Frequency Trading on an Electronic Market∗ Andrei Kirilenko|MIT Sloan School of Management Albert S. Kyle|University of Maryland Mehrdad Samadi|University of North Carolina Tugkan Tuzun|Board of Governors of the Federal Reserve System Original Version: October 1, 2010 This version: May 5, 2014 ABSTRACT This study offers an empirical analysis of the events of May 6, 2010, that became known as the Flash Crash. We show that High Frequency Traders (HFTs) did not cause the Flash Crash, but contributed to it by demanding immediacy ahead of other market participants. Immediacy absorption activity of HFTs results in price adjustments that are costly to all slower traders, including the traditional market makers. Even a small cost of maintaining continuous market presence makes market makers adjust their inventory holdings to levels that can be too low to offset temporary liquidity imbalances. A large enough sell order can lead to a liquidity-based crash accompanied by high trading volume and large price volatility { which is what occurred in the E-mini S&P 500 stock index futures contract on May 6, 2010, and then quickly spread to other markets. Based on our results, appropriate regulatory actions should aim to encourage HFTs to provide immediacy, while discouraging them from demanding it, especially at times of significant, but temporary liquidity imbalances. In fast automated markets, this can be accomplished by a more diligent use of short-lived trading pauses that temporarily halt the demand for immediacy, especially if significant order flow imbalances are detected. These short pauses followed by coordinated re-opening procedures would force market participants to coordinate their liquidity supply responses in a pre-determined manner instead of seeking to demand immediacy ahead of others.
    [Show full text]
  • The Federal Reserve's Response to the 1987 Market Crash
    PRELIMINARY YPFS DISCUSSION DRAFT | MARCH 2020 The Federal Reserve’s Response to the 1987 Market Crash Kaleb B Nygaard1 March 20, 2020 Abstract The S&P500 lost 10% the week ending Friday, October 16, 1987 and lost an additional 20% the following Monday, October 19, 1987. The date would be remembered as Black Monday. The Federal Reserve responded to the crash in four distinct ways: (1) issuing a public statement promising to provide liquidity as needed, “to support the economic and financial system,” (2) providing support to the Treasury Securities market by injecting in-high- demand maturities into the market via reverse repurchase agreements, (3) allowing the Federal Funds Rate to fall from 7.5% to 7.0%, and (4) intervening directly to allow the rescue of the largest options clearing firm in Chicago. Keywords: Federal Reserve, stock market crash, 1987, Black Monday, market liquidity 1 Research Associate, New Bagehot Project. Yale Program on Financial Stability. [email protected]. PRELIMINARY YPFS DISCUSSION DRAFT | MARCH 2020 The Federal Reserve’s Response to the 1987 Market Crash At a Glance Summary of Key Terms The S&P500 lost 10% the week ending Friday, Purpose: The measure had the “aim of ensuring October 16, 1987 and lost an additional 20% the stability in financial markets as well as facilitating following Monday, October 19, 1987. The date would corporate financing by conducting appropriate be remembered as Black Monday. money market operations.” Introduction Date October 19, 1987 The Federal Reserve responded to the crash in four Operational Date Tuesday, October 20, 1987 distinct ways: (1) issuing a public statement promising to provide liquidity as needed, “to support the economic and financial system,” (2) providing support to the Treasury Securities market by injecting in-high-demand maturities into the market via reverse repurchase agreements, (3) allowing the Federal Funds Rate to fall from 7.5% to 7.0%, and (4) intervening directly to allow the rescue of the largest options clearing firm in Chicago.
    [Show full text]
  • Dangers of Regulatory Overreaction to the October 1987 Crash Lawrence Harris
    Cornell Law Review Volume 74 Article 9 Issue 5 July 1989 Dangers of Regulatory Overreaction to the October 1987 Crash Lawrence Harris Follow this and additional works at: http://scholarship.law.cornell.edu/clr Part of the Law Commons Recommended Citation Lawrence Harris, Dangers of Regulatory Overreaction to the October 1987 Crash , 74 Cornell L. Rev. 927 (1989) Available at: http://scholarship.law.cornell.edu/clr/vol74/iss5/9 This Article is brought to you for free and open access by the Journals at Scholarship@Cornell Law: A Digital Repository. It has been accepted for inclusion in Cornell Law Review by an authorized administrator of Scholarship@Cornell Law: A Digital Repository. For more information, please contact [email protected]. THE DANGERS OF REGULATORY OVERREACTION TO THE OCTOBER 1987 CRASH Lawrence Harrist INTRODUCTION The October 1987 crash was the largest stock market crash ever experienced in the United States. Many people, remembering that the Great Depression followed the 1929 crash, expressed serious concerns about the 1987 Crash's potentially destabilizing effects. Fortunately, these concerns have not yet been realized. In hindsight, economic analyses show that the 1929 crash was only a minor cause of the Great Depression. The most important cause of the Depression was the tight monetary policy following the crash. The Federal Reserve failed to provide liquidity sought by the financial sector, and this led to several banking crises. The tight monetary policy was implemented in response to fears about infla- tion-the governors probably were overly impressed by the German hyperinflation. The Federal Reserve learned its lesson well.
    [Show full text]
  • Market Fragmentation, Mini Flash Crashes and Liquidity
    Market fragmentation, mini flash crashes and liquidity Ester F´elez-Vi~nas∗ Stockholm Business School January 12, 2017 Abstract This study analyzes the impact of market fragmentation on liquid- ity with a focus on episodes of mini flash crashes (defined as large price changes that are reversed within seconds). I find that in normal mar- ket conditions, market fragmentation improves liquidity as measured by quoted spreads and depth at best prices. When focusing on episodes of mini flash crashes, the results show that market fragmentation reduces the number of mini flash crashes and speeds up their recovery. Furthermore, market fragmentation is not a source of market instability. Liquidity shocks are mostly less harmful in fragmented, but interrelated markets than in concentrated markets. ∗Contact: [email protected] 1 1 Introduction Stock markets have evolved from local concentrated exchanges to fragmented structures that are comprised by traditional regulated exchanges and alterna- tive trading platforms such as Multilateral Trading Facilities (MTFs). Market fragmentation is the consequence of the implementation of recent regulations aiming to enhance fair competition in financial markets.1 Despite the raise in market fragmentation, its effects on market quality and especially, on market stability, are unclear. Regulatory authorities are concerned that market frag- mentation is a source of market instability and that it is behind recent episodes of liquidity dry-ups. To my knowledge, this paper is the first to analyze the im- pact of market fragmentation on liquidity in the presence of mini flash crashes, which are defined as large price changes that are reversed within seconds.
    [Show full text]