996416

research-article2021
AUM0010.1177/0312896221996416Australian Journal of ManagementHo et al.

Article

Australian Journal of Management

The effect of short selling on

2022, Vol. 47(1) 34­–52
© The Author(s) 2021
Article reuse guidelines:
volatility and jumps sagepub.com/journals-permissions
DOI: 10.1177/0312896221996416
https://doi.org/10.1177/0312896221996416
journals.sagepub.com/home/aum

Glenn Kit Foong Ho

UWA Business School, The University of Western Australia, Australia

Sirimon Treepongkaruna
The University of Western Australia, Perth, WA, Australia; Center of Excellence in Management Research for
Corporate Governance and Behavioral Finance, Sasin School of Management, Chulalongkorn University, Thailand

Marvin Wee
Research School of Accounting, College of Business and Economics, The Australian National University,
Canberra, Australia

Chaiyuth Padungsaksawasdi
Department of Finance, Thammasat Business School, Thammasat University, Bangkok, Thailand

Abstract
The evidence is mixed regarding the role of short sellers on stock market efficiency, with the
majority of studies assessing short selling activities during abnormal market conditions. This study
investigates the effect of short selling on stock volatility during normal market conditions in the
Australian stock market using various proxies for volatility and trading activities. While short
volume does not supplant the number of trades in the volume and volatility relationship, our
results suggest that short selling has some incremental positive effects on volatility. Overall, our
vector autoregression (VAR) analysis suggests that trading by short sellers increases volatility
even during normal market conditions.
JEL Classification: G10, G12, G13

Keywords
Jumps, order imbalance, realized volatility, short selling, trading volume

Corresponding author:
Chaiyuth Padungsaksawasdi, Department of Finance, Thammasat Business School, Thammasat University, 2 Prachan
Road, Bangkok 10200, Thailand.
Email: chaiyuth@tbs.tu.ac.th

Final transcript accepted 31 January 2021 by Tom Smith (AE Finance).

Ho et al. 35

1. Introduction
During periods of market turbulence, such as the 2008 Global Financial Crisis (GFC), the 2011
European debt crisis and the recent COVID-19 pandemic,1 short sellers are believed to exacerbate
volatile conditions and are thus banned in an attempt to stabilize stock markets.2 Little is reported
about the role of short selling in more stable periods, especially in Australia. Given this premise,
we question the necessity of short sell restrictions during normal market conditions. Specifically,
we ask whether short sellers indeed exacerbate price fluctuations in normal periods. To answer our
research question, we explore how short selling affects volatility and jumps for stocks on the
Australian stock market by using five different realized volatility measures during normal market
conditions.
Although short sellers are often blamed for extreme volatility in the market, existing studies
such as Chen et al. (2016), Hodgson et al. (2018) and Henry (2019) demonstrate that short sell-
ers have an important role in financial markets by facilitating price discovery. In the post-
implementation review3 of the 2008 temporary short selling ban prepared by the Australian
Securities and Investment Commission (ASIC) in 2012, the short selling ban was found to
benefit long-term investors. However, the ASIC also concluded that the ban adversely affected
industries that depend on the demand of short sellers for borrowed stocks and potentially nega-
tively affected the efficient operation of the market. Moreover, Huynh and Smith (2017) show
that momentum profits in the Australian stock market depend on the ability to short the bank-
rupted stocks that are usually included in the loser portfolios. Thus, when there is a short sale
constraint, this strategy might not be viable. Gao and Leung (2017) also identify a reduced
momentum profit during the GFC period (when short selling was banned) compared to the
period prior to the crisis. The majority of the prior literature examines the role of short selling
restrictions on market quality during times of market stress; instead, this article seeks to inves-
tigate the following research questions during normal market conditions: How do short selling
activities affect volatility? Are the effects of short selling activities on upside and downside
volatility asymmetrical? Are short selling activities associated with large unexpected price
movements (i.e. jumps)? To shed light on these questions, we examine the effect of short selling
activities on different measures and components of volatility. One of the measures we use to
calibrate the variability in returns is realized volatility, a measure advocated by Andersen and
Bollerslev (1998). In addition, we decompose the realized volatility into two components,
namely continuous and jump volatility, using the technique developed by Barndorff-Nielsen
and Shephard (2004). The continuous component is associated with normal news innovations,
whereas the jump component is associated with infrequent large movements in returns, typi-
cally associated with unexpected news innovations.4
Existing studies on the relation between short selling and volatility predominantly focus on
volatility around the period of short sale constraints and document mixed evidence on this relation.
On one hand, Bris (2008) and Boehmer et al. (2010) find an increase in volatility in US stocks with
a short sale ban in place during the 2008 GFC. Similarly, Chang et al. (2014) find an increase in
price efficiency and a decrease in stock return volatility after the removal of the short sale ban,
while Yeh and Chen (2014) provide evidence from price jump activities in the Taiwanese market
that short sale constraints destabilize the market. This is also supported by Helmes et al. (2017),
who find similar impacts in the form of an increase in intraday volatility, an increase in market
illiquidity and a decrease in trading activities among financial firms in the Australian stock market.
During normal market conditions with no short selling restrictions in place, Chang et al. (2007)
demonstrate an increase in prices and volatility and a decrease in positive skewness for selected
individual stocks on the Hong Kong Stock Exchange.
36 Australian Journal of Management 47(1)

Moreover, several studies indicate that short selling also influences corporate decision-making.
For example, Grullon et al. (2015) provide evidence that short selling activity in the United States
causes prices to fall and impacts firms’ financing and investment decisions. In a subsequent study,
Chen et al. (2019) find that pressures on short selling activities cause firm’s managers to change
cash dividend payment and stock repurchase policies.
In addition to these mixed results, the generalizability of the results is often questioned as the
analysis is most commonly based on periods associated with liquidity crises. If bans or restrictions
are in place due to the volatility in the market, it is then difficult to attribute the changes in volatility
to the short selling restrictions and not to the period examined. Consequently, the results from
many prior studies do not necessarily inform as to how short sellers affect volatility when there are
no liquidity crises or short sale constraints.
There is an extensive body of research on stock returns volatility (e.g. see Engle, 1993; Whitelaw,
1994). Schwert (1990) offers possible explanations for what is documented with long-term and
short-term volatility. He contends that long-term volatility may be caused by corporate leverage,
personal leverage, and business conditions while trading volume is likely to play an important role
in explaining short-term volatility. Recently, Dimpfl and Jank (2015), Tantaopas et al. (2016) and
Padungsaksawasdi et al. (2019) find that the relation between realized volatility and Google SVI,
proxied for retail investor attention, is consistent with the noise-trader hypothesis of excess
volatility.
In an attempt to find what determines stock volatility, Karpoff (1987) documents a positive rela-
tion between trading volume and stock return volatility. Subsequent studies by Schwert (1989),
Brailsford (1996) and Daigler and Wiley (1999) confirm this positive relation. This volume–vola-
tility relation is also robust to different financial markets, which include stocks, currencies and
futures. The current literature relies on three schools of theoretical models to explain the volume–
volatility relation.5 These models differ in the ways that they explain the relation, that is, the mix-
ture of distribution models by Clark (1973), Epps and Epps (1976) and Tauchen and Pitts (1983);
the asymmetric information models by Kyle (1985) and Admati and Pfleiderer (1988); and the
differences of opinion models by Varian (1985), Varian (1989) and Harris and Raviv (1993).
Our study extends the literature in several ways and addresses several unanswered research
questions. First, our study provides evidence on the relationship between short selling and volatil-
ity in normal market conditions. Second, our study adds to the literature on the volume–volatility
relation. Current research finds that the number of trades is the dominant factor in the volume–
volatility relation (Chan and Fong, 2006; Giot et al., 2010; Jones et al., 1994). While short volume
does not supplant the number of trades in the volume and volatility relationship, our results suggest
short selling has some incremental effects on volatility. Finally, our study provides further evidence
for the debate on the desirability of short sellers in financial markets during normal market condi-
tions. As evidenced by the 2008 GFC and the 2011 European debt crisis, policy makers have had
to make difficult decisions to placate the financial market. Australian regulators imposed short sell
restrictions in 2008. After the removal of these restrictions, our results suggest that short sellers
still destabilize the market, which is of serious concern to regulators. Thus, the role of short selling
remains the same, regardless of economic conditions. Our study therefore confirms that the prohi-
bition of short sellers is indeed necessary to ‘limit the potential for markets to become disorderly
due to short selling’ (p. 2).6
This article adopts five volatility measures: the realized volatility, continuous and jump compo-
nents of realized volatility, and upside and downside volatilities. Changes to reporting require-
ments by the ASX and the ASIC have made data on short selling more readily available. Using this
dataset, we investigate the level of short selling for each stock and examine the relationships
Ho et al. 37

between short selling and volatility. Overall, we find a positive relation between short selling and
volatility.
The remainder of this article is organized as follows. Section 2 describes the data and construc-
tion of the variables of interest, and Section 3 explains the methods used in this study. Section 4
discusses empirical results and Section 5 concludes the article.

2. Data, volatility, and short selling measures

2.1. Data
As the short selling reports containing the short selling data are only available from 14 December
2009, we commence our sample period on 15 December 2009 and end on 30 June 2011. This
period excludes the short selling ban that was in place in 2008.7 During this sample period, the S&P
ASX 200 value-weighted index reaches the lowest point of the index at 4238 and the highest at
4995 on 1 July 2010 and 14 April 2010, respectively. According to the definition of a bull and bear
market by Pagan and Sossounov (2003), the sample period is non-directional as the index mean
reverts to the level of 4600 and thus provides an ideal setting for our study.8 Our sample includes
the constituents of the ASX 200.9 Of the 200 companies in the index as at 15 December 2009, only
184 firms have complete trading records for the whole time period on the databases provided by
the Securities Industry Research Centre of Asia-Pacific (SIRCA). The ASX operates a fully auto-
mated order-driven trading system, where limit and market orders are executed in a continuous
auction during 10:00 a.m. to 4:00 p.m.10
Using the filtered data,11 the bid and ask quotes at 5-minute intervals are extracted to obtain a
midpoint price for the calculation of the daily volatility measures. Subsequently, the daily volatility
measures are merged with the short selling data from ASX and a second set of filters are applied.
We exclude days with missing short selling volume or total volume data. This criterion reduces the
sample by 4284 observations. Next, days where short selling volume is larger than total daily vol-
ume are removed as they are likely to be recording errors.12 The final sample comprises 184 stocks
with 68,894 firm-day observations.
To calculate the volatility and volume measures, data are retrieved from SIRCA AusEquities
Tick History databases. The trade and sales database allows the midpoint quote at various time
intervals to be identified and used to calculate a time series of intraday returns. Data from the order
book database that consists of all orders that enter or exit the order book are used to construct the
various volume measures. The database allows the initiator of a trade to be identified easily with-
out having to rely on the tick test or the Lee and Ready (1991) algorithm often used to identify
buyer- or seller-initiated trades.13
Data from the short selling reports are used to construct the short selling measures. Since the
inception of the short selling data reports on 14 December 2009, the supply of daily short selling
information from the ASX to the public is regulated by the Australian Securities and Investments
Commission through Class Order 08/751.14 The Class Order requires all participants (brokers) to
record a proposed sale as either a long sale or a covered short sale. If the participants make a
recorded short sale, they must inform the ASX of the total number of products short sold by the
start of the following trading day.15 Information received by the ASX is handled by the ASX
Settlement and Transfer Corporation and is subsequently made publicly available online three
business days later.16 The data used in this study are extracted from the daily gross securities
lending transaction reports that are made publicly available to market participants on the regula-
tor’s website. These reports provide a daily summary of the level of short selling activities and
the securities lending transaction volume. Securities lending transaction volume is defined as the
38 Australian Journal of Management 47(1)

total number of transactions per security effected or settled in the equity settlement system
(CHESS) that have been denoted as securities lending transactions. That is, it is the daily short
selling volume. The transparency that is associated with the level of securities lending in the
market makes the Australian equity market an ideal setting to examine the effects of short selling
on volatility.

2.2. Realized volatility

Following Jones et al. (1994), we use realized volatility as a measure of volatility. The use of real-
ized volatility is advocated by Andersen and Bollerslev (1998) and the measure, RVit , is defined
as the sum of the corresponding 1/∆ high-frequency intraday squared returns for stock i as

1/ ∆
RVit (∆) = ∑rj =1
2
t + j∆,∆ (1)

where rt + ∆ , ∆ ≡ p (t + ∆) − p (t ) is the discretely sampled ∆-period return and 1/∆ is the number of
intraday periods on day t .
Downside and upside volatilities are modelled because traditional measures of risk do not cap-
ture the portfolio objectives of portfolio managers. Portfolio managers and investors are typically
concerned about losses relative to a certain benchmark (Harlow, 1991). The idea that a unit of loss
is weighed more heavily than gains is also emphasized by Kahneman and Tversky (1979) in their
prospect theory when modelling expected utility. To examine how short selling affects these com-
ponents of risk, upside and downside measures are constructed to measure the extent of stock price
variability in a particular direction. These measures are adapted from Ahn et al. (2001) as follows

1/ ∆
RVit+ = ∑r
j =1
2
t + j∆,∆ ∀rt , ∆ > 0 (1a)

1/ ∆
RVit− = ∑r
j =1
2
t + j∆,∆ ∀rt , ∆ < 0 (1b)

where RVit+ ( RVit− ) is the upside (downside) volatility and is computed based on the summation of
squared positive (negative) intraday returns for stock i at time t . Barndorff-Nielsen et al. (2008)
show that these measures have similar properties and advantages as the realized volatility measure.

2.3. Continuous and jump components of realized volatility

Based on the theory of quadratic variation, Andersen and Bollerslev (1998) show that realized vari-
ation converges uniformly in probability to the increment of the quadratic variation process as the
sampling frequency of the underlying returns increases, suggesting that

t Nt

∫
RVt (∆) → σ 2 ( s )ds + ∑κ
j =1
2
t, j
(2)
t −1
Ho et al. 39

RVt (∆) → Integrated Variance + Jumps (3)

for ∆ → 0, where N t is the number of jumps on day t and κ t , j is the jth jump size on that day.
In general, realized volatility captures the dynamics of both the continuous sample path and the
jump process. That is, in the presence of jumps, realized volatility does not consistently estimate
integrated volatility as the measure captures both the continuous and discontinuous components of
volatility. Thus, the bi-power variation proposed by Barndorff-Nielsen and Shephard (2004) is
used to separate the two components of the quadratic variation process. Using this technique, we
are able to consistently estimate the integrated variance in the presence of jumps. The bi-power
variation, BV , is defined as the sum of the product of adjacent absolute intraday returns standard-
ized by a constant and is shown as follows
1/ ∆
BVt (∆) ≡ µ1−2 ∑r
j =2
2
t + j∆,∆ rt2+ ( j −1) ∆ , ∆ (4)

where µ1 ≡ 2 / π .
In the presence of discontinuous jumps, it can be shown that
t

BVt (∆) → σ 2 ( s )ds ∫

t −1
(5)

Therefore, the difference between the realized variation and the bi-power variation consistently
estimates the jump contribution of the quadratic variation process as follows

Nt
RVt (∆) − BVt (∆) → ∑κ
j =1
2
t, j when ∆ → 0 (6)

Following prior research, we treat small jumps as measurement errors or parts of the continuous
sample path process and treat the large values of the jumps as the ‘significant’ jump component
(Andersen et al., 2007). To determine if a movement is a jump, we compute the Z statistic as
follows

RVt (∆) − BVt (∆)  RVt (∆) −1

Z t (∆) ≡ ∆ −1/ 2 (7)
( ) { }
1/ 2
 µ1−4 + 2 µ1−2 − 5 max 1, TQt (∆) BVt (∆) −2 
 
where

1/ ∆

∑r
4/3 4/3 4/3
TQt (∆) ≡ ∆ −1 µ4−/33 2
rt2+ ( j −1) ∆ , ∆ rt2+ ( j − 2) ∆ , ∆ and µ4 / 3 = 22 / 3 Γ(7 / 6)Γ(1 / 2) −1 (8)
t + j∆,∆
j =3

TQt (∆) is the integrated quarticity and may be consistently estimated using equation (8). We
obtain the significant jumps by comparing the test statistics to a standard normal distribution. Under
the null hypothesis of no jumps, Zt (∆) has an approximately standard normal distribution and this
test has been shown to have reasonable power against several plausible stochastic volatility jump
40 Australian Journal of Management 47(1)

diffusion models. In order to compare the test statistics with the standard normal distribution, we
choose a significance level α and create an indicator variable, I t ,α (∆) ≡ I Z t (∆) > Φα  .17
The jump component is computed as J t ,α (∆) = I t ,α (∆) RVt (∆) − BVt (∆)  .
Andersen et al. (2007) suggest that the use of ‘staggered’ versions of the bi-power variation and
the integrated quarticity measures to tackle microstructure noise causes the high-frequency returns
to be autocorrelated. We define another integrated variance that allows the summation of the jump
component and the continuous component equal to realized volatility as follows

Ct ,α (∆) = 1 − I t ,α (∆)  RVt (∆) + I t ,α (∆) BVt (∆) (9)

Andersen et al. (2001) show that in their simulations, sampling at 5-minute intervals is optimal
and results in the lowest mean square error. As such, we use 5-minute sampling intervals to com-
pute realized volatility.

2.4. Short selling measure

We define the short selling measure, SVit , as the ratio between short sell volume and total volume
as follows18

Short SaleVolit
SVit = (10)
TotalVolit

where Short SaleVolit and TotalVolit are the amounts of short sales and total volume for stock i
at time t , respectively.
The use of order imbalance in the study of the relation between volume and volatility is moti-
vated through models, such as by Admati and Pfleiderer (1988) and Huang and Stoll (1997), pre-
dicting that price movements are caused by net initiated order flow. In Chan and Fong (2006),
order imbalance is defined as the absolute difference between the number of buyer-initiated trans-
actions and the number of seller-initiated transactions. As we are concerned with the activity of
short sellers versus sellers in general, we develop a new measure of order imbalance, OBSit , based
on the number of short sellers in the market relative to the total amount of seller-initiated trading
activity. This new measure is defined as follows

Short SaleVolit
OBSit = (11)
Total SellVolit

where Short SaleVolit is the number of short sales for stock i at time t.

3. Modelling framework
3.1. Bivariate vector autoregression
A bivariate vector autoregression (VAR) using the maximum likelihood estimation (MLE) is
adopted to investigate the effect of trading activity on volatility measures.19 All estimations use a
maximum lag length of six and the optimal lag lengths are determined by the Akaike information
Ho et al. 41

criterion. The parameters are estimated on an individual firm and reported as averages in each table
with their associated statistics. We study the effects of three trading activity variables, namely short
selling ( SV ) , short selling order imbalance (OBS ) , and number of transactions ( NT ) , respec-
tively, on several proxies of volatility as presented below.
First, to examine the effects of short selling ( SV ) on volatility, we estimate the following VAR
model
6
RM it = α1i + α 2i M t + α 3i SVit −1 + ∑α
k
4 + k ,i RM it − k + ϑit

6 (12)
SVit = β1i + β 2i M t + β3i RM it −1 + ∑β
k
4 + k ,i SVit − k + ε it

where RM = ( RV , RV − , RV + , C , J ) . Our realized volatility measures, RM it , have five different

forms as follows: (1) RVit is the realized volatility for stock i at time t; (2) RVit- is the downside
volatility for stock i at time t ; (3) RVit+ is the upside volatility for stock i at time t ; (4) Cit is
the continuous component of volatility for stock i at time t ; and (5) J it is the jump component of
volatility for stock i at time t. M t is the Monday dummy variable, which takes the value of 1 for
Mondays and 0 otherwise. Figure 1 plots the intraweek pattern of the three volatility measures
( RV , C , and J ) constructed using 5-minute returns. Consistent with Brown et al. (1992) and Tang
and Lui (2002), we find higher volatility on Mondays because of the weekend trading break.
Hence, we include the Monday dummy variable in all VAR models in all relationships.
Next, to examine how the short selling order imbalance measure affects volatility, we estimate
the following VAR model
6
RM it = α1i + α 2i M t + α 3i OBSit −1 + ∑α
k
4 + k ,i RM it − k + ϑit

6 (13)
OBSit = β1i + β 2i M t + β3i RM it −1 + ∑β
k
4 + k ,i OBSit − k + ε it

where RM = ( RV , RV − , RV + , C , J ) and are defined as above.

Finally, to investigate the impact of the number of trades on the realized volatility, we rely on
the suggestions by Jones et al. (1994), who find that the number of trades is the dominant factor in
explaining volatility. Our VAR specification is
6
RM it = α1i + α 2i M t + α 3i NTit −1 + ∑α
k
4 + k ,i RM it − k + ϑit

6 (14)
NTit = β1i + β 2i M t + β3i RM it −1 + ∑
k
β 4 + k ,i NTit − k + ε it

where RM = ( RV , RV − , RV + , C , J ) and NTit is the number of trades for stock i at time t.

3.2. Trivariate vector autoregression

It is well documented in literature that the number of trades is strongly related to volatility (Chan
and Fong, 2006; Jones et al., 1994). As such, we explore whether the inclusion of the short selling
42 Australian Journal of Management 47(1)

4.5 2.5

J
4.4 2.2
RV

C and J
4.3 1.9

RV

4.2 1.6

4.1 1.3

4 1
Monday Tuesday Wednesday Thursday Friday
Day of the Week

Figure 1. Intraweek daily volatility measures.

Figure 1 shows the volatility measures averaged by trading days for 184 companies over the period of 15 December
2009 to 30 June 2011. RV is the daily realized volatility computed using the sum of 5-minute squared returns. Realized
volatility is decomposed into its continuous and jump components denoted by C and J, respectively. All volatility
measures are scaled by 10,000.

volume provides any incremental explanatory power to the relationship between the number of
trades and stock volatility. We treat the number of trades as an endogenous variable in the follow-
ing trivariate VAR specification model
6
RM it = α1i + α 2i M t + α 3i SVit −1 + α 4i NTit −1 + ∑α k
5 + k ,i RM it − k + ϑit

6
SVit = β1i + β 2i M t + β3i RM it −1 + β 4i NTit −1 + ∑β k
5 + k ,i SVit − k + ε it (15)
6
NTit = δ1i + δ 2i M t + δ 3i RM it −1 + δ 4i SVit −1 + ∑δ
k
5 + k ,i NTit − k + ηit

where RM = ( RV , RV − , RV + , C , J ) . NTit and SVit are the number of trades and short selling ratio
for stock i at time t , respectively.
Ho et al. 43

4. Empirical results
4.1. Summary statistics
Panel A of Table 1 presents the summary statistics for the five volatility measures. In general, there
is considerable variation in the volatility measures across the entire cross section of stocks. The
daily average realized volatility ( RV ) across the sample period is 0.044%, and the daily average
upside ( RV + ) and downside volatilities ( RV - ) are similar at 0.022% and 0.023%, respectively.
The annualized RV , RV + , and RV - are 33.3%, 23.5, and 24.07%, respectively. These volatilities
are in line with those reported in Chan and Fong (2006) and Giot et al. (2010).
Consistent with expectations that jumps are by nature infrequent, the statistics show that at least
25% of the observations for the jumps have zero value. Further investigations (untabulated) show
significant jumps (α = 1%) identified for 23% of the observations; that is, jumps occur on 15,834
of the 68,894 firm-day observations. Both the skewness and kurtosis statistics show that the distri-
butions of the volatility measures are not normally distributed and right skewed. The non-normal-
ity of the volatility measures is consistent with the findings of Andersen et al. (2001) and Giot and
Laurent (2004).20 The summary statistics suggest the presence of outliers in the volatility meas-
ures. We verified that these are not recording errors by checking that these days are associated with
significant news releases.21
Panel B of Table 1 shows the summary statistics for the short selling measures. There is substan-
tial variation across the short selling and volume measures as evidenced by the top and bottom
quartiles. The average short interest (mean = 16%) indicates that approximately one in six stocks
traded on the ASX involves a short seller. This is similar to Boehmer et al. (2008) where 13% of all
NYSE volume involves a short seller. The maximum value shows that 94% of the stock volume for
a particular firm day involves a short seller, suggesting that some firms in our sample have substan-
tial short selling activities.
Panel C of Table 1 shows the statistics for the volume measures. The average daily volume (Vol)
per share is 4.2 million and the median is 1.6 million. Due to the trading in some of the larger stocks
within the sample, the volume measure is right skewed.22 Average daily buyer-initiated trades
(Buy) for each stock of 1.6 million shares is close to the average seller-initiated trades (Sell) of 1.46
million. This suggests that there is no systematic buying or selling pressure across all firms in the
sample period.
In addition, the short selling order imbalance (OBS ) provides some information about the type
of orders used by short sellers. Asquith et al. (2010) argue that short sales should be predominantly
transacted via market orders. If all short sellers use market orders, then the OBS should be bounded
by one because short sellers cannot exceed the total seller-initiated trades. However, the OBS
measure exceeds one, which indicates that the short sellers in our sample use both market and limit
orders when transacting.

4.2. Bivariate vector autoregressive model estimates

Panel A of Table 2 reports parameter estimates for equation (12) and a positive bivariate relation-
ship between short selling and the realized volatility measures. This table also shows the effect of
short selling volume on all five proxies of our volatility measures and vice versa. We find that the
effect of short selling on volatility is generally significant and mostly positive. The overall results
imply that short selling activity in the previous day does lead to an increase in volatility (albeit only
in a small proportion of stock, comprising less than one-third of the firms in our sample). Our find-
ings are consistent with the mixture of distributions model by Tauchen and Pitts (1983), where
44 Australian Journal of Management 47(1)

Table 1. Summary statistics of volatility measures and trade measures.

Mean Median SD 25th 75th Minimum Maximum Kurtosis Skewness

Panel A: Volatility Measures
RV 4.38 2.10 37.93 1.10 4.20 0.00 9262.71 52,012.84 215.74
RV− 2.30 1.05 34.49 0.53 2.14 0.00 8709.97 61,001.06 242.35
RV+ 2.21 1.01 8.72 0.51 2.08 0.00 880.01 4139.12 52.91
C 2.09 0.85 15.98 0.28 1.93 0.00 3356.57 30,072.73 154.41
J 2.28 0.88 23.58 0.00 2.20 0.00 5906.14 57,067.93 228.77
Panel B: Short Measures
SV 7.08 2.21 16.33 0.60 6.76 0.00 986.03 278.22 10.13
SI 0.16 0.14 0.12 0.08 0.22 0.00 1.00 2.25 1.21
Panel C: Volume Measures
Vol 42.12 16.36 87.39 5.55 42.66 0.00 4910.50 256.76 9.87
NT 2.36 1.58 2.58 0.75 2.94 0.00 35.21 10.60 2.72
TS 2.90 0.93 7.26 0.35 2.80 0.01 475.06 943.84 20.82
Buy 16.06 5.96 34.82 2.00 15.67 0.00 1295.44 146.29 8.47
Sell 14.62 5.37 32.48 1.84 14.13 0.00 1183.52 127.88 8.38
OBS 0.47 0.42 0.31 0.23 0.66 0.00 1.79 0.15 0.74

This table reports the summary statistics of the volatility measures, short selling measures, and the volume measures for
184 companies over the period of 15 December 2009 to 30 June 2011 (n = 68,894). Panel A reports the statistics for
the volatility measures. RV is the daily realized volatility computed using the sum of 5-minute squared returns. Realized
volatility is decomposed into its continuous and jump components denoted by C and J, respectively. RV+ and RV− are
the upside and downside volatilities. All volatility measures are scaled by 10,000. Panel B summarizes the statistics for
the short selling trade measures. SV represents short volume and SI is short volume divided by the total volume. SV is
scaled by 10,000. Panel C reports statistics for the volume trade measures. Vol represents volume, NT is the number of
trades a day, and TS is trade size. NT and TS are scaled by 1000. Buy and Sell represent buyer-initiated and seller-initiated
trades, respectively. Finally, OBS is calculated as short selling volume over daily seller-initiated trades. Vol, Buy, and Sell
are scaled by 100,000.

information is a mixing event that positively affects volume and volatility.23 Turning to the effect
of realized volatility on short selling, we find the results are largely similar to the effect of short
selling on realized volatility. Short selling activities are viewed as predatory and manipulative,
subsequently destabilizing financial markets. Thus, the larger the short sell volume, the higher the
volatility, and vice versa. Our findings emphasize that short sellers do indeed exacerbate market
uncertainty.
Panel B of Table 2 reports the results for equation (13), investigating the causal relationship
between short selling order imbalance (OBS) and the volatility measures. A positive bivariate rela-
tionship between short selling order imbalance and the realized volatility measures is found. The
findings are consistent with the microstructure models by Kyle (1985) and Admati and Pfleiderer
(1988), who demonstrate that prices are the consequence of net order flow, which signals informa-
tion to uninformed investors. The models suggest that prices increase (decrease) when excessive
buy (sell) orders occur. Thus, volatility in prices is influenced by net order flow. Like the short
selling volume–volatility relationship reported in Panel A of Table 2, the relationships are only
significant for less than one-third of the firms in our sample. As short sellers are typically sophis-
ticated investors with superior information, trading orders from them could trigger a movement in
stock prices and subsequently make the market more volatile. Our results are in line with the find-
ings of Opschoor et al. (2014), who document a positive order flow–volatility relationship in
futures markets. Thus, the larger the net order imbalance, the higher the volatility.
Ho et al. 45

Table 2. Bivariate vector autoregressive models.

RV RV- RV+ C J

Panel A: Short selling and volatility

6

RMit = α1i + α 2 i Mt + α 3i SVit −1 + ∑α

k
4+ k,i RMit − k + ϑit

SVt−1 0.4822 1.1526 1.2045 0.8114 0.3382

%+ Significant 9.78% 17.39% 9.24% 12.57% 9.84%
%– Significant 1.09% 0.54% 0.54% 0.00% 1.09%
6

SVit = β1i + β2 i Mt + β3i RMit −1 + ∑β

k
4+ k,i SVit − k + ε it

RMt−1 0.0021 0.0022 0.0054 0.0025 0.0031

%+ Significant 14.67% 10.33% 23.91% 12.02% 17.49%
%– Significant 0.54% 1.09% 0.54% 0.55% 0.55%
Panel B: Short selling order imbalance (OBS) and volatility
6

RMit = α1i + α 2 i Mt + α 3i OBSit −1 + ∑α k

4+ k,i RMit − k + ϑit

OBSt−1 0.4592 0.4796 0.4326 0.3221 0.3200

%+ Significant 14.13% 16.85% 14.67% 11.41% 13.04%
%– Significant 0.54% 0.54% 0.54% 0.00% 1.09%
6

OBSit = β1i + β2 i Mt + β3i RMit −1 + ∑β

k
4+ k,i OBSit − k + ε it

RMt−1 0.0061 0.0044 0.0175 0.0073 0.0104

%+ Significant 14.67% 8.15% 27.17% 11.96% 19.57%
%– Significant 0.00% 1.63% 0.00% 0.00% 0.00%
Panel C: Daily number of transactions and volatility
6

RMit = α1i + α 2 i Mt + α 3i NTit −1 + ∑α

k
4+ k,i RMit − k + ϑit

NTt−1 1.2057 1.1619 0.9630 0.8090 0.7973

%+ Significant 37.50% 39.13% 47.28% 43.72% 25.68%
%– Significant 0.00% 0.00% 0.54% 0.00% 0.00%
6

NTit = β1i + β2 i Mt + β3i RMit −1 + ∑β

k
4+ k,i NTit − k + ε it

RMt−1 0.8090 0.0658 0.0318 0.0337 0.0094

%+ Significant 43.72% 31.52% 19.02% 25.14% 17.49%
%– Significant 0.00% 1.09% 1.63% 1.64% 0.00%

This table reports the vector autoregressive model (VAR) results. All VAR models are estimated with maximum lag
length of six and the lag lengths utilized in the models are selected based on the Akaike information criteria. The
sample consists of 184 companies over the period of 15 December 2009 to 30 June 2011. All VAR parameters are
estimated for each firm and the means of the parameters are reported. Also reported are the percentages of significant
coefficients at the 5% level. Panel A reports estimates for bivariate model of relation between short selling and volatility
measures as shown in equation (11). Panel B reports estimates for bivariate model of relation between short selling
order imbalance and volatility as shown in equation (12). Finally, Panel C reports estimates for bivariate model of
relation between number of trades and volatility as shown in equation (14).
46 Australian Journal of Management 47(1)

Panel C of Table 2 shows the results for equation (14), investigating the causal relationship
between realized volatility and the number of trades (NT). Chan and Fong (2006) suggest that the
number of traders possesses the power to explain volatility, subsequently strengthening the vol-
ume–volatility relationship. Our results indicate that the relationship between the number of trades
and volatility prevails. We find that the number of trades has a strong bivariate relationship with
the realized volatility measures, demonstrating a cause-and-effect relationship. On average,
approximately 36% of the firm regressions have positive and significant coefficients.24 Based on
the average coefficient values, we observe that the lagged values of daily number of transactions
help explain changes in stock prices in the Australian equity market, and vice versa. This is consist-
ent with Ting et al. (2010), who examine the relationship between trading activity and volatility for
the top 50 stocks on the ASX.

4.3. Trivariate vector autoregressive model estimates: effect of short selling and
number of trades on volatility
Table 3 shows the results for equation (15), investigating the dynamic relationship between short sell-
ing volume (SV), the number of trades (NT), and volatility (RM). The effect of the number of trades
and the level of short selling on volatility are shown in Panel A of Table 3. The signs on NT are, on
average, positive for all volatility measures, showing that an increase in the number of trades causes
an increase in volatility for the following day. We also note that an inclusion of the number of trades
to the realized volatility-short selling VAR system yields stronger results, where we observe a larger
number of significant relationships at the firm level when compared to Table 2. Nevertheless, the
weak relationship between short selling volume and volatility prevails. The effect of short selling on
volatility is positive and significant for less than 7% of the firm regressions.
Panel B of Table 3 shows the effects of the number of trades and volatility on short selling vol-
ume. When compared with the results in Table 2, we note a drop in the number of significant coef-
ficients on the realized volatility variables when we include the number of trades in the models.
There is also a marginally stronger relationship between the number of trades and short selling than
that between realized volatility and short selling. This is particularly so for the models where vola-
tility is measured by the positive volatility ( RV + ) . This suggests that the prior day’s number of
trades better predicts short selling than the prior day’s volatility, especially in bullish markets.

5. Conclusion
When markets are turbulent, regulators around the world often blame short sellers for detrimental
excessive volatility. This study seeks to examine if trading by short sellers affects stock price fluc-
tuations in normal market conditions, and if so, how this trading affects information flow. Overall,
we find some evidence to suggest that short selling and short selling order imbalance positively
affect daily realized volatility measures.
Our study relies on the VAR approach to investigate potential relationships between short sell-
ing and realized volatility, the short selling order imbalance and realized volatility, and the number
of trades and realized volatility, respectively. Our findings are consistent across these three rela-
tionships, wherein the number of trades demonstrates the strongest relationship with the volatility
measures employed in our study. In addition, we find some weak evidence that short selling leads
to higher volatility.
Our findings contribute to the debate on the restriction of short sellers during crises and the
reversal of such restrictions after the crisis period. In early 2020, short sellers were restricted in
Ho et al. 47

Table 3. Trivariate vector autoregressive model estimates of order imbalance on volatility measures.

This table reports the vector autoregressive model (VAR) results. All VAR models are estimated with
maximum lag length of six and the lag lengths utilized in the models are selected based on the Akaike
information criteria. The sample consists of 184 companies over the period of 15 December 2009 to 30
June 2011. All VAR parameters are estimated for each firm and the means of the parameters are reported
from equation (15). Also reported are the percentages of significant coefficients at the 5% level.
6

RMit = α1i + α 2 i Mt + α 3i SVit −1 + α 4 i NTit −1 + ∑α

k
5+ k,i RMit − k + ϑit
(1)
6

SVit = β1i + β2 i Mt + β3i RMit −1 + β 4 i NTit −1 + ∑β k

5+ k,i SVit − k + ε it
(2)
6

NTit = δ1i + δ 2 i Mt + δ 3i RMit −1 + δ 4 i SVit −1 + ∑δ

k
5+ k,i NTit − k + η it
(3)
− +
where RM = (RV , RV , RV , C , J )

SV is the short selling volume divided by the total volume. M is a dummy variable that is equal to 1 for
Mondays and 0 otherwise. NT is the number of trades. RV is the daily realized volatility computed using
the sum of 5-minute squared returns. Realized volatility is decomposed into its continuous and jump
components denoted by C and J, respectively. RV+ and RV− are upside and downside volatilities computed
using the sum of positive and negative 5-minute squared returns, respectively. All volatility measures are
multiplied by 10,000.

RV RV - RV + C J
6

RMit = α1i + α 2 i Mt + α 3i SVit −1 + α 4 i NTit −1 + ∑α 5+ k,i RMit − k + ϑit

Panel A: k

SVt -1 NTt -1 SVt -1

SVt -1 NTt -1
NTt -1 SVt -1 NTt -1 SVt -1 NTt -1
Coefficient –2.1868 1.1545 –0.0199 0.8304 –1.2665 1.2055 –0.8118 0.8059 –0.9568 0.7554
%+ Significant 4.35% 35.87% 4.35% 42.39% 6.56% 38.80% 3.80% 40.22% 3.80% 24.46%
%– Significant 1.63% 0.00% 3.80% 0.54% 0.55% 0.00% 0.54% 0.00% 1.09% 1.09%
6

Panel B:
SVit = β1i + β2 i Mt + β3i RMit −1 + β 4 i NTit −1 + ∑β k
5+ k,i SVit − k + ε it

RVt -1 NTt -1 RVt--1 NTt -1 RVt+−1 NTt -1 C t -1 NTt -1 Jt -1 NTt -1

Coefficient 0.0007 0.0101 0.0034 0.0108 –0.0009 0.0127 0.0005 0.0127 0.0014 0.0104
%+ Significant 4.89% 19.57% 5.98% 16.30% 2.73% 22.95% 3.26% 22.83% 7.61% 22.28%
%– Significant 1.63% 0.00% 0.54% 0.00% 3.83% 0.55% 2.72% 0.00% 0.54% 0.00%
6

NTit = δ1i + δ 2 i Mt + δ 3i RMit −1 + δ 4 i SVit −1 + ∑δ 5+ k,i NTit − k + η it

Panel C: k

RVt -1 SVt -1 RVt--1 SVt -1 RVt+−1 SVt -1 C t -1 SVt -1 Jt -1 SVt -1

Coefficient 0.0345 0.4912 0.0359 0.4863 0.0666 0.5240 0.0369 0.4860 0.0117 0.5125
%+ Significant 27.72% 22.83% 16.85% 19.02% 26.78% 25.68% 25.00% 21.74% 16.85% 23.37%
%– Significant 0.54% 0.54% 2.17% 0.54% 0.55% 0.55% 1.09% 0.54% 0.54% 0.54%

certain parts of the world due to the COVID-19 pandemic; these restrictions were later reversed by
regulators, citing less volatile market conditions. Regulators often point to excess/reduced volatil-
ity as one of the reasons for restricting/relaxing the participation of short sellers. To this end, our
48 Australian Journal of Management 47(1)

study suggests that even during normal market conditions, short sellers do indeed contribute to an
increase in volatility. However, this increase is of a very small magnitude when compared to the
number of trades. As such, it is important for regulators to weigh the costs and benefits regarding
the participation of short sellers in the market.

Acknowledgements
We would like to thank anonymous referees and editors for helpful comments.

Funding
The author(s) received no financial support for the research, authorship and/or publication of this article.

ORCID iDs
Sirimon Treepongkaruna https://orcid.org/0000-0002-3096-8499
Chaiyuth Padungsaksawasdi https://orcid.org/0000-0002-2307-4454

Notes
1. See https://www.whitecase.com/publications/alert/short-selling-bans-and-market-restrictions-consider-
ations-investors for a list of countries with a temporary short selling ban in 2020.
2. For example, the Australian Securities Exchange (ASX) argues that the short sell ban during the Global
Financial Crisis (GFC) was necessary for financial stability purposes; see page 5 of ASX position paper
on the Transparency of Short Selling and Securities Lending (Australian Securities Exchange, 2008).
3. See https://ris.pmc.gov.au/2012/11/08/temporary-short-selling-ban-post-implementation-review-aus-
tralian-securities-and
4. The latent news process can be thought of as having two components: (1) normal and (2) unexpected
(Maheu and McCurdy, 2004). The normal news innovations are associated with smoothly evolving
changes in the volatility in returns (i.e. continuous component of stock return volatility), whereas the unex-
pected news innovations are associated with infrequent large movements in returns (i.e. jump component).
5. As there are no theoretical models underlying the potential relation between short sales and volatility, we
borrow from existing literature on the volume and volatility relationship.
6. Refer to ASIC Class order 09/39 explanatory statement.
7. Covered short selling of securities was banned between 21 October and 13 November 2008 and the ban
on certain financial stocks was extended to 25 May 2009. See Lecce et al. (2012) for a discussion on the
short selling regulation in Australia.
8. This sample period follows a bull market recovery after the GFC, where the market is observed to be
associated with broad upward movements. This classification of a bull market is consistent with Pagan
and Sossounov (2003), where they define a bull (bear) market as a market where prices experience a
broad increase (decrease) for more than 16 months.
9. Data for the constituents of the ASX 200 are retrieved from the Thompson Reuters Tick History available
from Securities Industry Research Centre of Asia-Pacific (SIRCA).
10. See Comerton-Forde and Rydge (2006) for a more detailed description of the ASX trading mechanism.
11. Before computing the various volatility measures, several filter procedures similar to those used in
Boehmer et al. (2005, 2007) are adopted to eliminate any database input errors. The initial sample con-
tains 8.2 million bid and ask quotes. Each bid and ask quote represent a limit order that is placed on the
ASX. First, we exclude quotes where the bid price is greater than the ask price. This criterion reduces
the sample by 4686 observations. Subsequently, a quote is removed if the bid (ask) is greater (less) than
150% (50%) of the previous bid (ask). This removes observations with extreme price movements that are
likely to be outliers, resulting in a further exclusion of 173 observations. Next, we exclude a quote if the
difference between the bid and ask is larger than 25% of the quote midpoint. The final sample comprises
8,195,939 observations.
Ho et al. 49

12. This removes one observation from the sample. The removal of one entry out of 68,895 suggests that the data
we have constructed from the short selling reports is reasonably accurate. However, we acknowledge that it
is not possible to detect recording errors where the short selling volume is lower than the total volume.
13. Aitken and Frino (1996) and Finucane (2000) find that these commonly used methods lead to significant
biases and inaccuracies when identifying trade initiators.
14. Class orders refer to the governance of a class of persons who carry out a particular activity in a certain
circumstance. Class Order 08/751 governs the reporting requirements upon the execution of short sales.
15. The Australian Corporations Act (reg 7.9.100A(1)) requires short sellers to report their short position.
Failure to comply with the disclosure requirements is an offence under the Corporations Act s1311
(Regulatory Guidance 196.10; see http://asic.gov.au/regulatory-resources/find-a-document/regulatory-
guides/rg-196-short-selling/). A seller may be exempted from reporting if their short position is suffi-
ciently small (i.e. less than or equal to $100,000 and 0.01% of the total quantity of securities or products
in the relevant class of securities or products). While a seller may be able to rely on the exemption, a
seller can choose to report all of its short position. This potentially adds noise to our data but is unlikely
to affect the results as the short selling position excluded would be small.
16. Short selling data is available from http://asic.gov.au/regulatory-resources/markets/short-selling/
short-position-reports-table/.
17. The smaller the significant level α, the fewer and larger (in magnitude) jumps we have.
18. We thank an anonymous referee and the editor for this suggestion.
19. We thank an anonymous referee for this suggestion.
20. Prior research shows that logarithmic transformations can change the distributions of the realized meas-
ures to become more normal. Results from the transformed volatility measures (not reported but avail-
able upon request) are consistent with the findings reported here.
21. In particular, we investigate two observations with daily realized volatility larger than 1000. The largest
realized volatility observation of 9262 is for Sigma Pharmaceuticals Limited (SIP) on 31 March 2010.
On that given day, SIP published their annual report and therein showed a 585.5% year on year decrease
of earnings. Consequently, share prices of SIP decreased 61% from $0.95 to $0.37. The second largest
realized volatility observation of 2148 is from PMP Limited (PMP) on 8 February 2010. Reports from
Morningstar FinAnalysis show that PMP announced a decrease in operating revenue of 9.5% which was
due to a decrease in its main business of printing of 17%. Share prices of PMP subsequently decreased
28% from 0.72 to 0.51 before closing at 0.65 at the end of the day. Together, this suggests that the price
movements were legitimate and not due to recording errors.
22. For example, the maximum value of 491 million is for Telstra (TLS) on 12 August 2010 when Telstra
released its annual financial results.
23. A large volume of existing studies document a strong positive relation between return volatility and trad-
ing volume (Alsubaie and Najand, 2009; Çelik, 2013; Chuang et al., 2012; Giot et al., 2010; Huang and
Masulis, 2003; Jones et al., 1994; Kao and Fung, 2012; Lee and Rui, 2002; Shahzad et al., 2014; Wang
and Huang, 2012).
24. In an unreported table, we investigate the dynamic relation between the number of trades and abnormal
short selling volume. The bivariate VAR shows a two-way relationship, in which the lagged abnormal
short selling seems to play more of a role than the number of trades. However, a larger number of trades
tends to create a higher short selling volume.

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