Do Short-Sales Costs Matter?

Noah Smith says that they do.

So in the equity market, shorts face huge disincentives, and longs don’t. That means over-optimistic longs get to set the price.

I am skeptical. Financial markets tend to find a way to work around barriers. For example, on alternative to shorting a stock is to buy a put option and write a call option.

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5 Responses to Do Short-Sales Costs Matter?

  1. mk says:

    “Financial markets tend to find a way to work around barriers.”
    This is silly. When you say that one alternative is to use options, don’t you think the cost of trading those options (bid/ask spread, price level etc.) will reflect the costs of shorting, since a dealer will be using the underlying market to hedge?

  2. cc says:

    What mk said.

  3. doombuggy says:

    since a dealer will be using the underlying market to hedge?

    If there is money to be made shorting the market, one could become a dealer and offer good deals.

    Going into any market requires a degree of optimism. Shorting goes against this optimism.

  4. MG says:

    Yes, they matter, so far as these “excess costs” arise from imperfect markets (markets that produce prices that academics and progressives) don’t like. Doing away with the up tick rule, banning periodic total bans on short selling, affording long term short sales gains long-term capital gain treatment, and even allowing insider trading (think of it as whistle blowing) could also, possibly, help too.

  5. Jack PQ says:

    Yes, financial markets can find ways, up to a point. But short-sales are constrained in unusual ways. Here is a great new paper (not mine!) that explains and investigates short-selling risks

    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2312625

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