Efficiency and the Bear: Short Sales and Markets around the World

We analyze cross-sectional and time series information from forty-seven equity markets around the world, to consider whether short-sales restrictions affect the efficiency of the market, and the distributional characteristics of returns to individual stocks and market indices. Using the approach developed in Morck et.al. (2000) we find significantly more cross-sectional variation in equity returns in markets where short selling is feasible and practiced, controlling for a host of other factors. This evidence is consistent with more efficient price discovery at the individual security level. A common conjecture by regulators is that short-selling restrictions can reduce the relative severity of a market panic. We test this conjecture by examining the skewness of market returns. We find that in markets where short selling is either prohibited or not practiced, returns display significantly less negative skewness, and the frequency of extreme negative returns is lower. On the other hand, the overall volatility of individual returns and market returns is higher.