Wednesday, November 26, 2008

Banning short-selling is bad

Why? Here’s the answer.
Banning short-selling delays price adjustment to the correct value. [...]

If a certain stock (or other asset) is overvalued, yet the people who realize this have already gotten out of the stock, then the way for them to correct this overvaluation is to sell the stock short. That way, these informed investors can bring the price closer to its fair value. But if short-selling is banned, this kind of adjustment can’t take place.

Another aspect of this is that people who for some reason believe a certain stock is too cheap can use their money or even borrowed money to buy stocks they think are too cheap. Yet people who come to the conclusion that a certain stock is overvalued can’t do anything about it unless they already owned the stock in the absence of short-selling.

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