The 2011 European short sale ban: A cure or a curse?

• During the ban, short positions in banned (non-banned) stocks decreased (increased).
• The ban itself increased implied jump risk levels, especially for banned stocks.
• After the ban's announcement, contagion risk dropped for banned stocks.
• Trading shifted from single stock puts into index options, reducing systemic risk.
• Bans should be used when financial stability outweighs transitory market failure.

This paper examines whether the 2011 European short sale ban on financial stocks proved to be successful or had a negative impact on financial markets. We explicitly take an options market perspective and focus on market participants’ changes in beliefs and expectations. During the ban, short positions in banned stocks decreased, whereas they increased for non-banned stocks. Our results indicate that the ban increased implied jump risk levels, thereby negatively impacting the banned financial stocks. However, we also observe that after the announcement of the ban, financial contagion risk actually dropped for banned stocks. Instead of a substitution effect between regular short selling and synthetic shorting through single stock puts, we observe a migration out of single stock puts into the EuroStoxx 50 index options market. We conclude that this type of migration diversified selling pressure initially concentrated in financial stocks across a larger share of the stock market, thereby reducing systemic risks and enhancing overall financial stability.