The cross market effects of short sale restrictions

• The paper explores the impact of short sales restrictions on the transmission of shocks between different stock markets.
• Using data on 26 stock markets and a VAR structure we show that the presence of short sales can dramatically change the transmissions between markets.
• Markets which imposed short sales were less vulnerable to shocks from other markets which also imposed short sales.
• However short sales constraints provide little protection from shocks originating in markets without these constraints.

This paper considers the impact of the 2008 short selling bans on the cross-market dynamics of stock indices across a wide range of countries. We measure the transmission of shocks between markets using a modified version of the spillover index of Diebold and Yilmaz (2009). The results show that the transmission of shocks between countries which did impose short sale bans was reduced and transmissions from countries with bans to countries without bans were also generally lower. In contrast, short sale bans did not provide protection from shocks emanating from countries which did not impose bans, as shocks from non-banning markets tended to have an increased impact on other markets during periods where bans were in place. Overall, the evidence supports the redirection of volatility in the system affecting the relationships between the groups of markets with bans and those without.