Shortselling – why is it only limited to books?

I have been thinking about posting my comments on this short-selling for a while. But kept forgetting. This recent Economist story reminded me to write on short-selling.

You often read this in press or see on TV (this is an imaginative case):

Q: People believe that speculation has a role to play in financial markets? What is your take on it?

Economist: Speculation is good for market. And if prices are rising and are beyond fundamentals, there are short-sellers who can lead to correction in asset prices

I wish all this was true. The short-selling activity isn’t anything what we read in finance books.  After all it is central to efficient markets. However, it is lied as long as it is in books but not in practice. Short-sellers are not just in a poor minority but are often despised. Infact, in the language of Alvin Roth it is a repugnance activity and no one likes it. It is often banned in crisis times and is then revisted later.

Mostly, the blame lies on regulation for not letting short-selling flourish but even the various market participants don’t like it. Infact, in times of declining asset prices, most would like short-selling to be banned.  All like long-buyers (opposite of short-sell) but no one likes the short-sellers. After all financial markets flourish on the basis of being positive and short-sellers are anything but positive.

Just think of two scenarios- when prices are rising and when prices are falling. In first you have long-buyers and in second you should have short-sellers. However, you do see long-buyers being extremely active in the first stage but hardly see any short-sellers with all kinds of interventions. The interventions are not just because regulators feel the need but they are pushed by other stake-holders amidst cries of despair and hopelessness – small investors, market participants etc.

This is what even the Economist story says

IT IS difficult being a short-seller. Most shareholders and managers agree that you are an important part of an efficient stockmarket—until you dump shares in their company. Then things can turn nasty. “We appreciate that, ****” barked Enron’s chief executive, on a public conference call, to a suspected short-seller who had complained about the lack of a published balance sheet. Sometimes bears need even thicker skins. In 1995 Malaysia’s finance ministry reportedly proposed caning as a punishment for abusive shorting.

I don’t really know the solution. It is human nature to be proud of gains and be extremely averse to losses/declines. May be behavioral economics can provide some solutions. Because, unless we have effective short-selling mechanism in place,  you can hardly expect markets to be efficient.

2 Responses to “Shortselling – why is it only limited to books?”

  1. Assorted Links « Mostly Economics Says:

    […] JRV points naked short-selling is banned in 19 financial stocks in US. I have mentioned earlierthat shortselling is limited to books. I had also pointed (see this as well) that experts in India […]

  2. SEC bans short-selling in 799 financial stocks « Mostly Economics Says:

    […] is a classic case of repugnance good and short-selling being limited to only text-books. When prices rise and are seen to be away from fundamentals, all say it is very difficult to say […]

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