Requiring short-sellers to disclose their positions more often is a better policy approach than imposing restrictions and bans, research from Saïd Business School, University of Oxford, has found. But too frequent disclosure could have a negative effect on market efficiency.
‘Despite overwhelming evidence that short-sellers are rational, informed traders who possess superior information, regulators still regard them with suspicion and often impose constraints on their activities,’ said Bige Kahraman, Associate Professor of Finance, Oxford Saïd. ‘We found that requiring greater disclosure can be better for the market than banning or restricting short-selling, but policy-makers should tread carefully: too much transparency may put short-sellers off acquiring valuable information.’
In Show Us Your Shorts! Dr Kahraman and co-author Salil Pachare, US Securities and Exchange Commission (SEC), examined trading patterns before and after revised SEC disclosure rules came into effect in September 2007. As a result of the amended rules, member firms of all major securities exchanges increased the frequency of reporting stock-level short interest (the number of shares that have been sold short but not yet covered or closed out) from once to twice per month.
The analysis showed that more frequent disclosure of short interest hastens the diffusion of information, and thus improves price efficiency. Short interest announcements in the middle of the month act as an informative signal that help investors anticipate future news related to company fundamentals.
Greater disclosure of short interest was also seen to reveal short-sellers’ private information more quickly to the market. This increases liquidity as it reduces information asymmetry between investors.
The revised SEC disclosure rules are not only beneficial for the market but also for the short-sellers. Because short-sellers’ information is now more quickly incorporated into prices, the horizon risks that short-sellers face are significantly reduced – that is, the risk that the mispricing can take too long to correct or the risk that short-sellers may end up liquidating their positons early due to large adverse price movements.
‘Our study showed that disclosing short interest twice per month improved informational efficiency, and therefore market efficiency and liquidity,’ said Dr Kahraman. ‘However it is important to remember that increasing the frequency of disclosures yet further is unlikely to result in corresponding market improvements. If short-sellers were to disclose their positions before they fully build them up, their profits would reduce. Other investors would take advantage of their information and their trading could move the stock price before the trade is completed. This would hurt short-sellers’ incentives to gather private information and worsen market efficiency.’
