Bans on short-selling in the eurozone are unlikely to prevent share prices from continuing to fall and could cause “more harm than good”, according to a major new study.

With European stock markets in turmoil, regulators in France, Italy, Spain and Belgium yesterday imposed a flurry of restrictions to stabilise share prices and restore order in the markets.

But a global study of the short-selling ban introduced during the financial crisis suggests the latest measures could inflict serious damage on the stock market.

In the largest study of its kind, Cass Business School [1], which is part of City University London, examined the impact of the ban on 30 countries using data from nearly 17,000 stocks between 2008 and 2009.

The findings provide new and compelling evidence that curbs on short-selling fail to support stock prices, severely reduce liquidity and restrict the flow of information to the market.

Co-author of the report, Professor Alessandro Beber from Cass, said: “According to our study, the knee-jerk reaction of most stock exchange regulators around the globe had a severely damaging effect on market liquidity. This was especially pronounced for stocks with small market capitalisation, high volatility and no listed options.

“The fall in liquidity was particularly dangerous because it came at a time when bid-ask spreads were already high as a result of the crisis, and investors were desperately seeking liquid security markets due to the freeze of many fixed-income markets.

“Our evidence convincingly shows that bans are bad for liquidity and do not help to support prices. This should send a strong message to regulators that fresh bans on short-selling could cause more harm than good.”

The study, due to be published in the highly-respected Journal of Finance, provides an unique insight into the effect of bans on ‘naked’ and ‘covered’ short-selling in 30 countries.

According to the report, Italy was hardest hit by the ban, followed by Denmark, Australia and Switzerland. Professor Beber said: “We found countries which already have liquidity problems because of the structure of their capital markets suffered the most damage from the ban.”

Spain, Belgium, Norway, Ireland, USA, UK experienced the next largest fall in liquidity while the Netherlands, South Korea and Austria were among those least affected.

Professor Beber said the ban also failed to achieve its overall aim of restoring order to the market and preventing the collapse of share prices. “In contrast to the regulators’ hopes, the overall evidence indicates that short-selling bans at best left stock prices unaffected and at worst may have contributed to their decline,” he said.

He added: “The evidence also shows that short-selling bans made stock prices slower in reacting to new information. By restraining the trading activity of informed traders with negative information about companies, the ban slowed down the speed at which news fed through to market prices.”