Impacts of Short-Selling Bans on the Korean Stock Market

Abstract

In this thesis, we examine the impacts of short-selling bans on the Korean stock market, particularly during periods of heightened volatility. Our view of the market can be simplified; we view the market as a large voting machine. The two sides of the market, long and short, are each working against each other in voting on the development of asset prices. Removing short positions can have significant consequences. We will analyse whether the regulators actions gave the intended results in their attempt at stabilizing the market during the market crisis of 2020.

Short-selling is a financial strategy where investors sell securities they do not own, anticipating a price decline to repurchase them at a lower price, thus pocketing a profit. Regulating this practice has historical precedence, with bans often implemented during financial crises in an attempt to reduce the volatility, stabilize markets and protect investors. The thesis specifically focuses on the Korean stock market, which has experienced several regulatory changes in response to recent economic shocks.

Our method consists of determining if there is a statistically significant difference in the volatility of the time series data before and after the ban implemented in 2020, to see if the policy achieved its intended effects. As for our quantitative analysis, we have applied the Standard GARCH, EGARCH and GJR-GARCH - models. In addition, a thorough discussion on measuring changes in time series data will be provided. For our testing, we will examine the variance in the daily returns between the KOSPI 100 and the KOSPI Small Cap indices and examine if there is a heightened volatility ex-post. Our research method consists primarily of a quantitative analysis with a comprehensive review of secondary data.

Our findings indicate that short-selling bans do lead to an increase in volatility, supporting our hypothesis that the policy does not achieve its intended effects. In addition, a thorough discussion on other potentially harmful effects, such as increased price discrepancies from fundamental values and decreased market efficiency will be provided.