Stabilizing the market with short sale constraint? New evidence from price jump activities

- We examine the impact of short-sale constraints (SSC) on market stabilization.
- We avoid the issue of reverse causality by exploring the realized jump activities.
- We devise an equilibrium measure to proxy for the strength of limit to short sell.
- Restraining SSC helps little in stabilization but increases the downside risks.

We re-examine the impact of short-sale constraints (SSC) on market stabilization via realized jump activities during 2002-2009 to circumvent the reverse causality in identifying the policy effects of SSC. We observed that the abnormal downturns under tighter short sale constraints are significantly larger whereas there is no difference for abnormal upturns. Our empirical results survive across a sequence of robustness examinations controlled for market illiquidity. The findings do not support the claims by regulators that restraining short-sales can stabilize prices; instead, SSC has led to a less efficient market with stronger extreme downward returns.