Do short selling restrictions destabilize stock markets? Lessons from Taiwan

Short sellers have been routinely blamed for triggering, or exacerbating, stock market declines. The experience of Taiwan provides an interesting case study of the impact of short selling bans on stock returns volatility in a time series framework due to the length of time the short selling ban was in place there. Estimating several variants of an asymmetric GARCH model and a Markov switching GARCH model we find robust evidence that short selling restrictions raise stock returns volatility. The only qualifier is that the impact of short sale bans is a feature of the expansionary phase of business cycles. During recessions this effect dissipates.