On the importance of fiscal space: Evidence from short sellers during the COVID-19 pandemic

Stefan Greppmair, Stephan Jank and Esad Smajlbegovic in this Bundesbank paper show that shortsellers anticipate countries with less fiscal space will not be able to provide stimulus in case of a crisis.

Our study suggests that short sellers anticipated the importance of fiscal space. During the stock market collapse in February 2020, we see a clear rise in short positions in companies with low liquidity headquartered in countries with a poor credit rating. In countries with a good credit rating, we do not observe this change in short sellers’ strategy. This trading strategy suggests that short sellers incorporate the limited ability of fiscally constrained governments to support firms with liquidity problems into their decisions. We find that they shifted their strategy ahead of the market collapse, anticipating the importance of fiscal space. Their strategy resulted in high abnormal returns during the market downturn period of the pandemic.  

The sample is thirteen EU countries and UK and Norway. Now we know EU countries do not have fiscal space as they do not have their own currency. The open short positions are higher in UK perhaps because of London being a financial centre and lower in Norway. The Modern Monetary Theory folks would ask for a better sample of countries.

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