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Short-Selling Equity Exchange Traded Funds and Its Effect on Stock Market Liquidity

Published online by Cambridge University Press:  15 March 2021

Egle Karmaziene Open the ORCID record for Egle Karmaziene [Opens in a new window]  and
Valeri Sokolovski Open the ORCID record for Valeri Sokolovski [Opens in a new window]
Egle Karmaziene
Affiliation:
Vrije Universiteit Amsterdam Finance [email protected]
Valeri Sokolovski*
Affiliation:
HEC Montréal Finance Department
*
[email protected] (corresponding author)
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Abstract

We examine short selling of equity exchange traded funds (ETFs) using the 2008 short-sale ban. Contrasting the previously documented contractions in bearish strategies during the ban, we find a significant increase in short sales of the largest, most liquid ETF, the S&P 500 Spider. We offer evidence suggesting that this upsurge was driven primarily by investors circumventing the ban. We show that the ban’s detrimental effect on stock liquidity was around 30% less severe for the Spider’s constituents. Our results suggest that ETF shorts can substitute for short sales of individual stocks, thereby alleviating short-sale constraints’ adverse effect on liquidity.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 57 , Issue 3 , May 2022 , pp. 923 - 956
Copyright
© The Author(s), 2021. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

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Footnotes

The article was previously circulated as “Beware of the Spider: Exchange Traded Funds and the 2008 Short-Sale Ban.” We thank Bo Becker, Janis Berzins, David C. Brown (the referee), Tolga Cenesizoglu, Jaewon Choi, Jennifer Conrad (the editor), Magnus Dahlquist, Lammertjan Dam, Francesco Franzoni, Mariassunta Giannetti, Lawrence Glosten, Paul Hanouna, Bob Hodrick, Charles Jones, Bige Kahraman, Kathryn Kaminski, Markku Kaustia, Albert Menkveld, Simon Rottke, Kirsten Smart, Chester Spatt, Marti G. Subrahmanyam, Paul Tetlock, Tomas Thörnqvist, and Patrick Verwijmeren for their comments. We also thank the seminar and conference participants at the Bank of Lithuania, Columbia Business School, International Monetary Fund, 2018 International Risk Management Conference, McGill University, Mutual Funds, 2019 Hedge Funds and Factor Investing Conference, Swedish House of Finance, University of Cape Town, University of Groningen, Vilnius University, and Vrije Universiteit Amsterdam.

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