China isn’t the only place beastly short sellers are identified as a problem in poor markets. In recent years governments all over the world have intervened from time to time to suspend the work of these agents; but does this assist or retard price discovery?
The authors of the paper (from 2013) highlighted this week, Asher Curtis and Neil F. Fargher from the Universities of Washington and the Australian National University sum up thus; ‘Limiting short-selling following price declines is likely to impede efficient price discovery.’ So there you have it.
They note, somewhat tongue in cheek, that regulators recognize short selling activity in buoyant markets as the action of sophisticated investors aiding efficiency and encouraging price discovery. In stressed markets though these same agents become shabby pirates threatening the survival of the financial system whose activities must be suspended. Funny old world.
What Curtis and Fargher demonstrate, by analyzing data from NASDAQ, the NYSE and AMEX from 1995 to 2011, is that short sellers target companies with declining stock prices AND weak fundamentals. There’s no evidence, from their data, of momentum alone being a strategy i.e. short sellers don’t sell stocks just because they’re going down.
They suspect the reason they don’t target expensive but stable stocks is the cost of holding onto positions; which helps to explain the persistently dear stock syndrome [Tencent? Ed.] which we’re all familiar with.
So, to get back to the title of the paper, it may be a bit of the former but short selling mostly produces a lot of the latter, even in falling markets. Not that regulators are likely to take much notice; ultimately they answer to a constituency that believes stock price falls must always be somebody’s ‘fault’. The same constituency that believes stock price rises are the product of skill, due diligence and an innate ability to pick winners. Funny old world indeed.
Happy Sunday.
[You can access the paper in full via this link Does Short Selling Amplify Price Declines]