Study of the impact of the European Short Sell Regulation on the European stock markets' liquidity, volatility and price formation process

This study tries to evaluate the impact of a recent European law concerning short sell regulation, in application since November 2012, on the stock markets. By putting a frame and limit some short sell practice; the European regulation could have modified some primary market characteristics: this is the core questioning of this paper: “Did the regulation voted by the European Parliament have impacted the market, and if yes did it worsen or improved it?” The markets’ impacts of the regulation are discussed on a 3-measures basis: market liquidity, volatility and price formation process. First, a literature review describes the core characteristics of the short sell product and the main motivations of such activity are enunciated. In addition to that, previous theories in the field of short selling and its impact on short sell regulation on markets is described: It is indicated that major academicians’ papers tend to argue that short sell regulation has a negative impact on the markets. Indeed, after such regulation, negative impacts have been seen on liquidity, volatility and price discovery process of stock markets. Then, the quantitative analysis deeper describes and develops measures of market liquidity, volatility and price formation process. On a second step, the Difference-indifference methodology used to compute and evaluate impact of the European short sell regulation is enunciated. Finally the findings section exposes results of potential impact of the regulation on market liquidity, volatility and price formation process. By this paper, it is exposed that the SSR did not have clear negative impact on the European stock markets. This finding was true for market liquidity, volatility and price formation process.