Stata:

- Twoway fixed effects

- Check how new panel data behaves
- Testing for two-way fixed effects models

4 Data

Data description:

- Explain exclusions
- Explain variation in price, 1 and 265.000 for Rohtschild
-

5 Empirical results

The objective of this thesis is to determine what the effect of the covered sort sale ban was on stocks
affected by the ban. Moreover, to investigate the difference of the effects of the covered short sale ban
between affected stocks with listed options and those without. The regressions results of the effect on
market liquidity and price efficiency are displayed in table xx.

Possible table

Build 1 Build 2 without With Build 3 Before After

As discussed in the literature review the short sale ban is assumed to have decreased market liquidity
and price efficiency of the affected stocks. As can be seen from the estimates market liquidity and price
efficiency increased for the affected stocks relative to the stocks that were not affected by the covered
short sale ban. These results will be discussed in more detail in the subsequent subsections.

All regressions are conducted with panel estimates in order to incorporate stock and time specific
effects. In these finance panel datasets are often plagued by groupwise heteroskedasticity, cross-
sectional dependence and autocorrelation. As discussed in the methodology section, it is important to
take into account these effects calculate robust standard errors and use robust tests in case the data
suffer of the effects above.

A. The effect of the short sale ban on market liquidity

The effect of the covered short sale ban on liquidity is measured by both the effect of the ban on the
bid-ask spread and the Amihud illiquidity ratio.

The estimates of the effect of the short sale ban on the bid-ask spread is displayed in column 1 and on
the Amihud illiquidity ratio in column 2 of table 2. Both estimates are conducted with fixed effects,
Driscoll-Kraay standard errors and autoregressive disturbances. The choice for this specification is
discussed in the next two paragraphs.

The estimates of the bid-ask spread and the Amihud illiquidity ratio exhibits both groupwise
heteroskedasticity and cross-sectional dependence, as is indicated by the Modified Wald test and the
Pesaran heteroskedasticity. As is described in the methodology section in that case it is important to use
the robust Hausmann test to determine whether estimates should be conducted with fixed effects. For
both the estimates of the bid-ask spread and the Amihud illiquidity ratio the null hypothesis of the
random effects is valid is rejected at a significance level of 5% which indicates that the fixed effect model
is the correct model. Moreover, as discussed in the literature review there are theoretical reasons to
believe that there are firm specific effects that influence both the liquidity and the bid-ask spread of
stocks. Since there are theoretical reasons to assume that there are stock fixed effects and the
Hausmann test indicates the presence of the them, the estimates are conducted with stock fixed effects.
Next to stock specific effects the presence of time fixed effects is tested. No time dummies are included
for both estimates since the F-test of the time dummies is rejected at a significance level of 5 %.

As discussed the data exhibits both groupwise heteroskedasticity as well as cross-sectional dependence.
Therefore robust standard errors have to be calculated that take into account the groupwise
heteroskedasticity and the cross-sectional dependence. As discussed in the methodology section, this
can be done in the case of fixed effect estimates with Driscoll-Kraay standard errors.

Hypothesis 1a is that the bid-ask spread for stocks affected by the short sale ban has increased relative
to the stocks that are not affected by the ban. Hypothesis 2a is that the illiquidity of stocks affected by
the short sale ban increased relative to the stocks that are not affected by the ban. Therefore for both
the estimate of the bid-ask spread and the Amihud illiquidity ratio, banned x event is assumed to be
positive. As can be seen in the estimates in column 1 and 2 of table 2, the coefficients are significantly
negative. The estimates show that the percentage bid-ask spread of the affected stocks decreased by
2.9%, which indicates that the absolute spread of the banned stocks decreased on average by 0.9
eurocent1. This can be seen as a considerable decrease in the trading costs. Unfortunately it is difficult
to calculate a meaningful statistic for the Amihud illiquidity ratio.

The estimates reveal thus that that contrary to the hypothesis the bid-ask spread of the affected stocks
decreased and the liquidity increased. There are two possible explanations. First of all, the
interpretation of the short sale ban as a decrease in the number of trades is too simple and maybe the
change in the ratio of informed vs uninformed investors has to be considered. Secondly, there may have
been events that influenced the stocks affected by the ban during the ban period which resulted in the
decrease of the bid-ask spread and increased of the liquidity of the affected stocks.

1
This is calculated as: estimated coefficient X average bid-ask spread x average stock price banned stocks.
So far the short sale ban is interpreted as a decrease in the number of short sales. In order to
incorporate the change in the ratio of informed versus uninformed traders, the short selling activity
before and during the ban have to be analyzed. The period before the short sale ban can’t be seen as a
normal short selling market. Short selling costs were at a historical height due and are likely to have
increased the ratio of informed traders relative to uninformed traders. {CITATION}During the short sale
ban all short sales were eliminated except for market makers. Market makers were allowed to sell short
to hedge their positions and provide liquidity. Both these types of trades can be seen as uninformed
trades. Therefore it is likely that the short sale ban has decreased the ratio of informed traders relative
to uninformed traders since there were only uninformed trades. Consequently the short sale ban
decreased the number of sort sales but also decreased the ratio of informed trades to uninformed
trades. The decrease in the number of short sales is expected to increase the bid-ask spread and
decrease liquidity whereas the decrease in the ratio of informed traders is expected to decrease the bid-
ask spread and increase liquidity. In case that the latter effect is stronger than the effect of the reduction
of the number of short sales, the short sale ban will have decreased the bid-ask spread and increased
liquidity as the estimates also show.

The other explanation is that there specific information for the stocks affected by the ban during the ban
period occurred. During the period of the ban several rescue packages were announced that were
mainly targeted at the stocks that were affected by the ban {CITATION}. These rescue packages
increased the clarity about fundamentals of the value of these firms. Consequently this could have
decreased the bid-ask spread and increased liquidity of these stocks. Therefore the decrease in the bid-
ask spread and increase in liquidity could be caused by the announcement of the rescue packages
instead of by the short sale ban.

Hypothesis 1b is that stocks effect by the short sale ban with listed options will have an increase in the
bid-ask spread relative to the stocks that are affected by the short sale ban without listed options.
Hypothesis 2b is that stocks effect by the short sale ban with listed options will have an increase in the
Amihud illiquidity ratio relative to the stocks that are affected by the short sale ban without listed
options. Therefore the coefficient of option x banned x event is expected to be positive for both
estimates. This is the case as both coefficients are significantly positive at a 1% significance level. The
estimates reveal that the percentage bid-ask spread of the affected stocks with listed options increased
by 2.4% relative to the stocks affected by the ban without listed options. This resembles an increase in
the absolute bid-ask spread of about 0.7 eurocent 2, which can be seen as an economic significant
increase.

There is thus clear evidence for hypothesis 1b and 2b, that the availability of listed options on banned
stocks increases the bid-ask spread and the illiquidity of the stock. This is in line with the theoretical
model of Diamond and Verecchia (1987) that argues that if the ratio of informed traders relative to
uninformed traders increases, the bid-ask spread will increase and the liquidity of the stock will
decrease. Therefore these estimates support the idea that the availability of options during the short
sale ban is likely to have increased the ratio of informed traders relative to the informed traders.

2
This is calculated as: estimated coeffient X average bid-ask spread x average stock price banned stocks.
For the estimates of the bid-ask spread and the Amihud illiquidity ratio there are no coefficients for
banned, option, option x banned and naked short constraint. These variables are omitted due to near
perfect collinearity. This nearly perfect collinearity comes from the stock fixed effects. All these 3
variables are stock specific elements that are constant over time and in estimates that are conducted
with random effects, these variables are not omitted 3. The constant is also omitted due to nearly perfect
collinearity.

For both estimates the coefficients of event and option x event are negative; indicating that the average
spread (resp. Amihud illiquidity ratio) for all stocks in the sample was smaller during the period of the
ban. This effect was even stronger for the stocks with listed options as option x event is negative.
However, the coefficients of event are not significant different from zero and therefore nothing really
can be said about this estimated coefficient.

The control variable volatility is as expected positive, more volatile stocks tend to have a wider spread
and be less liquid. Furthermore market capitalization is expected to be negative, as stocks with a larger
market capitalization tend to have smaller spreads and a higher liquidity. In contrast, the estimates show
a significant positive estimate for the bid-ask spread and a significant negative estimate for the Amihud
illiquidity ratio. It is puzzling why stocks with a larger market capitalization have larger spreads according
to these estimates,

Maybe model fit. Normality of the residuals..

B. The effect of the short sale ban on price efficiency

The effect of the short sale ban on price efficiency is measured by both the level of idiosyncratic risk and
the autocorrelation of past market returns. The estimates of the effect of the short sale ban on the level
of idiosynchratic risk is displayed in column 3 and on the autocorrelation of past market returns in
column 4 of table 2. Both estimates suffer again from groupwise heteroskedasticity, cross-sectional
dependence and autocorrelation. The robust hausmann test rejects the null hypothesis of unbiased
estimates. Therefore the estimates are again conducted with fixed effects, Driscoll-Kraay standard errors
and autoregressive disturbances.

Hypothesis 3a is that the level of idiosyncratic risk is lower for stocks affected by the short sale ban. This
is due t to more difficult to absorb stock specific information. Furthermore hypothesis 3b is that this
decrease for the affected stocks was smaller if there are listed options, since it facilitates the
incorporation of information into the stock prices.

As can be seen in column 3 table 2 is that the coefficient of banned x event is negative and significant,
contrary to what is expected based on the hypothesis. This indicates that the level of stock specific
information was larger for stocks that were affected by the ban. However, this effect is relatively small.
The average r squared during the event was 15% and for the affected stocks it decreased to 13%.

3
These estimates are available on request to the author.
The coefficient of option x banned x event is as expected negative, but insignificant. Consequently it is
not possible to either accept or reject hypothesis 3b.

A possible explanation for the increase of stock specific information could be that besides the short sale
ban there are other factors changed for the affected stocks during the ban period, and thereby masked
the effects of the ban. For example, if the short sale ban limited the incorporation of stock specific
information, but there was also more stock specific information, than there may be no overall effect at
all. During the short sale ban there was a considerable amount of stock specific information for the
affect firms in the form of the rescue packages and news regarding the financial position of these firms.
This information has probably moved the stock prices of the firms affected by the short sale ban more
than other financial firms. The reason is that the firms affected by the ban were affected more by the
financial crises than other financial stocks. Consequently, if the effect of the increase in the amount of
stock specific information dominates the effect of the decrease in the ability to incorporate stock
specific information, the estimate can become negative as is the case. In this case the problem that the
firms affected by the ban were not selected at random, but that these were the firms were selected
because they were affected most possibly plays a role.

The reason that the hypothesized effect of the availability of listed options is insignificant could be that
there are more substitutes for short sales available. Next to options futures can be used as substitutes
and thereby can facilitate the incorporation of stock specific information. This could then mask the
effect of both the short sale ban and the availability of listed options.

Hypothesis 4a states that the short sale ban decreased the ability to incorporate information in stock
prices and thereby increased the autocorrelation of past returns Furthermore hypothesis 4b states that
the availability of listed options increases the ability to incorporate the information and therefore the
effect will be smaller for the affected stocks with listed options.

As can be seen in column 4 of table 2 the coefficient of banned x event is as expected positive and
significant. However, the effect is very small. For example if a stock has a price decrease of 10 percent a
banned stock will experience another 0.0003 percent decrease the next day. Since the average stock
price of banned stocks is 4.79 euro this equals only 0.00001 euro. Therefore it is clear that this estimate
is economically insignificant.

Furthermore the estimate of option x banned x event is statistically insignificant. This reveals that the
availability of options did not have a significant effect on the autocorrelation of past returns of the
banned stocks.

The lack of a significant larger autocorrelation of negative market returns and stock prices of the banned
stocks could either be present but masked by other effects or the hypothesized effect did not exist. The
reason that the effect is not visible could be as already discussed that there was a lot of stock specific
information for the banned stock during the ban. These price movements can possibly have masked the
autocorrelation of past market returns. The other possibility is that the incorporation of negative
information was simply not hindered by the short sale ban. This could either be the case if the
hypothesized effect does not exist, or in case that there are other substitutes available than options that
thereby reduce the effect of the short sale ban.

The insignificance of the effect of the availability of listed options for the stocks affected by the short
sale ban makes sense. In case that there was no significant effect for of the ban, the availability of
options can no longer decrease the effect of the short sale ban.

For both the estimate of the r squared as well as the autocorrelation of past negative market returns
there was a priori no expectation for the signs of event and option x event. As can be seen in column 3
and 4 these effects are relatively small and most of them are insignificance. However, since these
variables are part of the interaction effect it is important to keep them in the equation. The F-test for
both estimates shows that the coefficients all together are significantly different from zero. Moreover,
the residuals are normally distributed.??

So far the effect is studied based on the estimates of the complete sample, but before a the fina;
conclusion can be derived it is important to test the robustness of the results. This will be done in the
nexct section.

Robustness of the results

The robustness of the results will be tested by comparing different time periods, an estimate with
outlier detection and a different frequency of the data.

Explain the robustness tests…

The estimates to test the robustness of the effect on the bid-ask spread are reported in table xx andf for
the robustness of the changes in the Amihud illiquidyt table have a look at table xx.

without outliecan be

it makes sense that the estimates of the effect of the availability of listed options is also

The estimate of the effect of the availability of listed options is very small and statistically insignificant.
Therefore the only conclusion that can be inferred from this estimate that there is no effect.

is is economically an insignificant result.

, the next day the stock price is expected

the stock would on average have an additional decrease in the price of on average the banned stock
would the price during the ban The coefficient of is positive but insignificant.

b this effect is also

Affecte most by the fiunancial crises plays again a role.

information about the rescue packages and the financial position of the affected firms. This stock
specific information influenced the stockpirces and therefore it is possible that this maks the effect of
the short sale ban.

If there was during the ban more specific information was available for the banned stocks that moved
their stockpirces. During the banned period more specific information about the affected firms came
available. Therefore it is possible that Reasons for insignificance, both decrease but increase in absolute.
Measurement problems ???

negative as expectedFurthermore the coefficient of This negative.

. Consequently the coefficient of xxx is expected to be negative and of xx to be positive.

Therefore the has increased relative to the stocks that are not affected by the ban. Hypothesis 2a is that
the illiquidity of stocks affected by the short sale ban increased relative to the stocks that are not
affected by the ban. Therefore for both the estimate of the bid-ask spread and the Amihud illiquidity
ratio, banned x event is assumed to be positive. As can be seen in the estimates in column 1 and 2 of
table 2, the coefficients are significantly negative. The estimates show that the percentage bid-ask
spread of the affected stocks decreased by 2.9%, which indicates that the absolute spread of the banned
stocks decreased on average by 0.9 eurocent 4. This can be seen as a considerable decrease in the
trading costs. Unfortunately it is difficult to calculate a meaningful statistic for the Amihud illiquidity
ratio.

4
This is calculated as: estimated coefficient X average bid-ask spread x average stock price banned stocks.