Does banning short selling work?

They did so in an attempt to check the plunging share prices of some banks. The implication of the action is that its instigators believe that the falls are being made worse by short-term speculative activity.

The proponents of short selling, on the other hand, argue that share prices reflect deeper factors and that any impact of short term trading on price levels is transitory at best. Short sellers do not make the weather but simply anticipate it.

Who is right?

Well, as it happens we have already had a controlled experiment in 2008, when the UK and other authorities did much the same as their counterparts yesterday. 

When it was over the IMA asked itself the question whether the ban had been effective. 

We simply looked at average daily share price movements in the three months leading up to the ban on 19 September, and then during the period of the ban itself.  This is what we found.

Average daily price movement:

Pre-Ban: 20 Jun - 19 Sep 08
- FTSE 100-0.23%
- FTSE 350 financial-0.20%

Post-Ban: 20 Sep - 31 Dec 08
- FTSE 100-0.07%
- FTSE 350 financial-0.42%

In other words, in the run up to the ban financial stocks were falling at much the same rate as the market as a whole.  But once the ban was in place, the fall in financials accelerated, while the rest of market steadied.

So whatever drove down the price of financial stocks in 2008 it doesn't look like it was short selling.  And banning short selling did not seem to do much to check the declines - the stocks went into freefall anyway.

On the basis of the evidence, the proponents of short selling would seem to be right and the regulators wrong.