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How does short selling affect liquidity in financial markets?

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  • Blau, Benjamin M.
  • Whitby, Ryan J.

Abstract

The paper seeks to determine whether short selling increases or decreases liquidity in U.S. equity markets. On one hand, prior research indicates that short sellers may act, at times, as liquidity providers. On the other hand, other research in market microstructure argues that spreads will widen in the presence of informed traders – a classification generally given to short sellers. Results from a series of new, multivariate time-series tests show that exogenous shocks to short selling activity generally lead to a widening of bid-ask spreads in smaller-cap stocks. The results, however, do not hold for larger-cap stocks.

Suggested Citation

  • Blau, Benjamin M. & Whitby, Ryan J., 2018. "How does short selling affect liquidity in financial markets?," Finance Research Letters, Elsevier, vol. 25(C), pages 244-250.
    • Handle: RePEc:eee:finlet:v:25:y:2018:i:c:p:244-250
    DOI: 10.1016/j.frl.2017.10.030
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    References listed on IDEAS

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    Cited by:

    1. Liew, Ping-Xin & Lim, Kian-Ping & Goh, Kim-Leng, 2020. "Does proprietary day trading provide liquidity at a cost to investors?," International Review of Financial Analysis, Elsevier, vol. 68(C).

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    More about this item

    Keywords

    Short sales; Asymmetric information; Liquidity; Bid-ask spreads; Time series; Vector autoregression; Impulse response functions;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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