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Predatory Short Sales and Bailouts

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  • Sebastian Kranz
  • Gunter Löffler
  • Peter N. Posch

Abstract

This paper extends the literature on predatory short selling and bailouts through a joint analysis of the two. We consider a model with informed short sales, as well as uninformed predatory short sales, which can trigger the inefficient liquidation of a firm. We obtain several novel results: A government commitment to bail out insolvent firms with positive probability can increase welfare because it selectively deters predatory short selling without hampering desirable informed short sales. Contrasting a common view, bailouts can be optimal ex ante but undesirable ex post. Furthermore, bailouts in our model are a better policy tool than short selling restrictions. Welfare gains from the bailout policy are unevenly distributed: shareholders gain while taxpayers lose. Bailout taxes allow ex ante Pareto improvements.

Suggested Citation

  • Sebastian Kranz & Gunter Löffler & Peter N. Posch, 2019. "Predatory Short Sales and Bailouts," German Economic Review, Verein für Socialpolitik, vol. 20(4), pages 469-491, November.
    • Handle: RePEc:bla:germec:v:20:y:2019:i:4:p:e469-e491
    DOI: 10.1111/geer.12173
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    References listed on IDEAS

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    JEL classification:

    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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