The restrictions imposed on short-selling financial stocks in the United States from 19 September to 8 October contributed around 20 basis points (bps) to the wider spreads experienced by affected stocks during the ban period, according to research by Credit Suisse’s Advanced Execution Services (AES) division.
“Based on the relationship between volatility and spreads before and after the restriction, we would have expected the spreads to be around 20 bps lower during the short-sell restriction than was actually the case,” the study said.
The bank detected wider spreads in restricted stocks during the ban period, but also noted that the increased volatility and reduced trading volumes over the period also contributed to the wider spreads.
However, the study found that changes in trading volume were not necessarily correlated to spread movements. Although spreads increased when trading activity declined, they returned towards pre-restriction levels after the ban, even though reduced volumes persisted.
Neither were spreads fully correlated to volatility, Credit Suisse reported. Spreads in restricted stocks peaked at 60 bps in early October when the restrictions were still in place, and then fell back to around 35 bps. Volatility, however, continued to rise steadily after the ban was lifted.
Spreads in unrestricted stocks did not follow the same trend as those in financial firms and other companies protected by the ban. Credit Suisse used the Dow Jones index as a proxy for shortable stocks. “We found that while spreads gradually increased in October (along with volatility), they did not jump during the restriction period as we observed that restricted stocks did,” the study said. During the ban, non-restricted stocks’ spreads were around 20 bps, and restricted stocks around 40 bps.
On examining the ratio restricted to non-restricted stocks’ spreads, the bank found a marked increase during the restricted period that reverted afterwards. The ratio was around 5 before the ban, rising to around 9 after the ban started and reaching a peak of 13 mid-way through the ban. The ratio fell back to around 6 after the ban expired. “This demonstrates that spreads of restricted stocks widened more than stocks not subject to the restriction,” the study said.
To quantify the effect of the short-selling restrictions on spreads, Credit Suisse measured the effects of volatility on spreads in periods before and after the ban and extrapolated this to estimate what spreads would have been in the restricted period had the ban not been in place.