Financial crisis, REIT short-sell restrictions and event induced volatility

From September 19 through October 8, 2008 the SEC issued a short sale moratorium on approximately 800 financial stocks. The emergency order justified the ban based on concerns “that short selling in the securities of a wide range of financial institutions may be causing sudden and excessive fluctuations in the prices of such securities” (see Securities and Exchange Commission, 2008). Although Real Estate Investment Trusts (REITs) were initially excluded, the management of fourteen REITs requested that they be added to the restricted list. Diamond and Verrecchia (1987) develop a model in which short sale constraints decrease trading and increase the time required to adjust to new information resulting in greater price reaction. This research employs a GARCH version of the market model to test the impact of the SEC policy on the risk/return of the fourteen restricted REITs and a sample of fifty REITs not on the list. Rather than mitigate volatility it was determined that fifty of the sixty-four REITS in the combined samples exhibited significant event induced risk as a consequence of the ban with a significantly larger increase occurring among restricted REITs. A cross-sectional test failed to identify significant negative or positive abnormal returns as a consequence of the short sell ban.

► This research employs a GARCH version of the market model to test the impact of the SEC short sell restricted list on the risk/return of fourteen restricted REITs and a sample of fifty REITs not on the list.
► Rather than mitigate volatility it was determined that fifty of the sixty-four REITS in the combined samples exhibited significant event induced risk as a consequence of the ban with a significantly larger increase occurring among restricted REITs.
► A cross-sectional test failed to identify significant negative or positive abnormal returns as a consequence of the short sell ban.