Carlos A. Ulibarri

Regulating noisy short-selling of troubled firms?

Purpose - The purpose of this paper is to examine the efficacy of recent policy initiatives taken by the US Securities and Exchange Commission banning naked “short-selling” of specific financial stocks. The paper also considers the merits of reinstating “uptick rule” 10a-1, which prohibits short-selling securities on a downtick. Design/methodology/approach - The paper studies theoretical implications of short-selling in a simple state-claim model, reflecting varying amounts of short interest in a representative firm and noise trading in the market. Price discovery depends on the proportion of noise trading compared to rational short-selling. The empirical analysis focuses on price volatility under short-selling constraints employing simple regressions, EGARCH analysis and simulated price behavior under a hypothetical uptick rule. Findings - The EGARCH results suggest short-selling constraints had non-uniform impacts on the persistence and leverage effects associated with price volatility. The corresponding price simulations indicate a hypothetical uptick rule might have helped stabilize price behavior in some cases, depending on the nature of the stochastic process and whether or not quantity constraints on short-selling are binding. Originality/value - The theoretical arguments and empirical findings suggest a “focused approach” to market regulation would be a more efficient means of discouraging trend chasing without compromising “informed trading” – that is to say, safeguarding price discovery and market liquidity without impeding arbitrage or confounding probability beliefs regarding firm survival. These conclusions are largely in accord with recent policy analysis and proposals outlined in Avgouleas.

Introducing Contemporaneous Open-Outcry and E-Trading at the Chicago Board of Trade

This study uses a vector error correction (VEC) model to examine price-volume relation- ships between open outcry and e-trading at the Chicago Board of Trade. We test whether equilibrium price corrections on one system are independent of the other, and whether this price behavior is more sensitive to changes in screen-based volume as opposed to open outcry volume. Error correction terms capture an asymmetric price adjustment process led by open outcry trading. Open outcry volume (market depth) also results in price discovery by dampening price volatility on both markets. These aspects of market microstructure are relevant in identifying how newly introduced e-trading systems operate in relation to established open outcry systems, and how e-trading systems may affect the economic performance of futures exchanges generally.