2008 SEC Short Selling Ban: Impacts on the credit default swap market

by Samuel Courtney of Stanford University

May 19, 2010

Abstract: On September 17, 2008, the Securities and Exchange Commission (SEC) issued an emergency order banning the shorting of 797 financial stocks. This paper studies the impact of the short selling ban on the credit derivatives market by investigating credit default swap (CDS) prices during the period that the ban was in effect. The hypothesis is proposed that the short selling ban on 797 financial stocks led market participants to enter CDS contracts to reflect positions that the participants had formerly entered through short sales, thus driving up CDS rates.  Analysis compares the CDS prices of firms protected by the ban to the CDS prices of similar firms in the S&P 500 not covered by the ban.  Tests are also conducted using metrics from the bond and equities markets to determine if the results from the CDS market are unique to the CDS space.  A linear regression technique is used to test the significance of the ban on CDS prices.  The study results indicate that the CDS prices of firms covered by the short selling restrictions experienced significant dislocations during the period of the ban.

JEL Classification: G10, G14, G18, G20.

Keywords: SEC short selling ban, credit default swaps, credit derivatives.

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