Handbook of Short Selling Handbook of Short Selling Greg N. Gregoriou Editor AMSTERDAM • BOSTON • HEIDELBERG • LONDON NEW YORK • OXFORD • PARIS • SAN DIEGO SAN FRANCISCO • SINGAPORE • SYDNEY • TOKYO Academic Press is an imprint of Elsevier Academic Press is an imprint of Elsevier 225 Wyman Street, Waltham, MA 02451, USA The Boulevard, Langford Lane, Kidlington, Oxford, OX5 1GB, UK © 2012, Elsevier Inc. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or any information storage and retrieval system, without permission in writing from the Publisher. Details on how to seek permission, further information about the Publisher’s permissions policies and our arrangements with organizations such as the Copyright Clearance Center and the Copyright Licensing Agency, can be found at our website: www.elsevier.com/permissions. This book and the individual contributions contained in it are protected under copyright by the Publisher (other than as may be noted herein). Notices Knowledge and best practice in this field are constantly changing. As new research and experience broaden our understanding, changes in research methods, professional practices, or medical treatment may become necessary. Practitioners and researchers must always rely on their own experience and knowledge in evaluating and using any information, methods, compounds, or experiments described herein. In using such information or methods they should be mindful of their own safety and the safety of others, including parties for whom they have a professional responsibility. To the fullest extent of the law, neither the Publisher nor the authors, contributo rs, or editors, assume any liability for any injury and/or damage to persons or property as a matter of products liability, negligence or otherwise, or from any use or operation of any methods, products, instructions, or ideas contained in the material herein. Library of Congress Cataloging-in-Publication Data Gregoriou, Greg N., 1956- Handbook of short selling / Greg N. Gregoriou. p. cm. ISBN 978-0-12-387724-6 1. Short selling. 2. Speculation. 3. Risk-taking (Psychology) I. Title. HG6041.G725 2012 332.64'5–dc23 2011020284 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library. For information on all Academic Press publications visit our Web site at www.elsevierdirect.com Typeset by: diacriTech, Chennai, India Printed in the United States of America 111213141516 7654321 Preface This handbook differs from other edited books because on a global scale it addresses new rules and regulations about short selling. Quan titative papers in this book use the latest data available, but more importantly, the papers are written by well-known academics and money managers. Many investors believe that short sellers are responsible for market down- turns, but academic theory does not suggest this. Instead, short sellers create liquidity in markets and are the best at spotting overpriced stocks as well as m aking markets more efficient through the aid of p rice discovery. This short selling handbook comes at a time when financial markets world- wide are recuperating from the credit crisis and the global c arnage of 2008. It can assist investors, hedge fund managers, investment analysts, research analysts, lawyers, account ants, endowments, found ations, and high net worth i ndividuals to better understand short selling during and after the crisis of 2008. The 39 chapters in this handbook will be a valuable source of information to anyone interested in short selling. Among its most exciting subjects are views of what the regulators temporarily did to ban shor t selling in o rder to prevent markets from further collapse. Contributors look both at developed global markets and emerging markets. They also take up naked short selling, the ethics of short sell ing, and other important issues. The first section of the book is devoted to regulation in the United States with a chapter for Canada. The second section examines both eastern and western European m arkets, while the third focuses on Japan, China, and Australia. Section four investigates short selling in Russia and in emerging marketssuchasinLatinAmericaandSouthAfrica.Thefifthsectionexam- ines portfolio management and performance of short biased hedge funds, xvii short selling by portfolio managers, and more. The last section addresses modeling, earnings, announcements, and term structure in a short selling framework. In short, the book does a tour of every c ontinent to investigate short selling during the recent market meltdown. For more information see the companion site at http://www.elsevierdirect .com/companion.jsp?ISBN=9780123877246 xviii Preface . Acknowledgments I thank the handful of anonymous referees during the selection process. In addition, I also thank J. Scott Bentley, Ph.D., executive finance editor at Elsevier, for his helpful sugge stions to ameliorate this book, Kathleen Paoni, editorial project manager as well as Heather Tighe, associate project manager at Elsevier. I also thank Sol Waksman, president at Barclay Hedge, for sup- plying hedge fund data for Chapter 29. In addition, we thank PerTrac for the use of PerTrac Analytics which enabl ed critical parts of our analysis in Chapter 29. Each contributor is responsible for his or her own chapter. Neither the editor nor the publisher is responsible for chapter content. xix About the Editor A native of Montreal, Professor Greg N. Gregoriou obtained his Joint Ph.D. at the University of Quebec at Montreal (UQAM) in Finance which merges the resources of Montreal’s four major universities UQAM-McGill-Concordia-HEC. He is Professor of Finance at State University of New York (Plattsburgh). He has published 43 books, 60 refereed publications in peer-reviewed journals, and 20 book chapte rs since his arrival at SUNY Plattsburgh in August 2003. His books have been published by McGraw-Hill, John Wiley & Sons, Elsevier-Butterworth/Heinemann, Taylor and Francis/CRC Press, Palgrave-Macmillan, and Risk Books. In addition, his articles have appeared in the Review of Asset P ricing Studies, Journal of Portfolio Management, Journal of Futures Markets, European Journal of Operational Research, Annals of Opera- tions Research, Computers and Operations Research,etc.ProfessorGregoriou is hedge fund editor and editorial board member for the Journal of Deriva- tives and Hedge Funds, as well as editorial board member for the Journal of Wealth Management,theJournal of Risk M anagement in Financial Institutions, Market Integrity, IEB International Journal of Finance,andtheBrazilian Busi- ness Review. Professor Gregoriou ’s interests focu s on hedge funds, funds of funds, and C TAs. He also is Research Associate at the EDHEC Business School in Nice, France . xxi Contributor Bios Paul U. Ali is an associate professor in the Faculty of Law, University of Melbourne, and a member of that law faculty’s center for Co rporate Law and Securities Regulation. Prior to becoming an academic, Paul was, for sev- eral years, a l awyer in Sydney. Paul has published widely on banking and finance law, derivatives, securitization,andstructuredfinance,including,in 2009, a book on credit derivatives. Paul has also recently participated in Joint India-IMF a nd M alaysia-IMF training programs as p art of an IMF project on derivatives in emerging markets. DavidE.Allenis a professor of finance a t Edith Cowan University, Perth, Western Australia. He is the author of three monographs and over 70 refereed publications on a diver se rang e of topics covering corporate finan- cial policy decisions, asset pricing, business economics, funds management and performance bench-marking, volatility modeling and hedging, and market microstructure and liquidity. Jørgen Vitting Andersen, Ph.D., is a physicist and a senior researcher at CNRS, University of Nice (France). He has broad international experience and has worked at the following universities: Paris X (France), McGill (Canada), Nordita (Denmark), and Imperial College (UK). Over the last 10 years he h as published a series of seminal papers in the new domain of econophysics, applying ideas from complexity theory to financial markets. Paul Brockman is the Joseph R. Perella and Amy M. Perella Chair of Finance at Lehigh University. He holds a B.A. degree in interna tional studies from Ohio State University (summa cum laude), an M.B.A. degree from Nova Southeastern Unive rsity (accounting minor), a nd a Ph.D. in finance (eco- nomics minor) from Louisiana State University. He received his certified public accoun tant (CPA) designation (Florida, 1990) and worked for several years as an accountant, cash ma nager, and futures and options trader. His xxiii academic publications have appeared in such journals as the Journal of Finance, Journal of Financial Economics, Journal of Financial and Quant itative Analysis, Journal of Banking and Finance, Journal of Corporate Finan ce ,andthe Journal of Empirical Finance, among others. Pau l has served as a member of the editorial board for the Journal of Multinational Financial Management and the Hong Kong Securities Institute’s Securities Journal. Soufiane Cherkaoui awa its admission to practice law in the state of New York and is presently an LL.M. d egree candidate in the Fordh am University School of Law Corporate, Banking and Finance Law program. He holds a Juris Doctor from Pace University Law School and a B.A. from New York University. Graciela Chichilnisky has worked extensively in the Kyoto Protocol process, creatin g and designing the carbon marke t concept t hat becam e international law in 2005. She also ac ted as a lead author of the Intergovernmental Panel on Climate Change, which received the 2007 N obel Prize. A frequent key- note speaker and special adviser to several UN o rganizations and heads of state, her pioneering work uses i nnovative mark et mecha nisms to redu ce carbon emissions, conserve biodiversity and ecosystem services, and improve the lot of the poor. She is a professor of economics and mathematical statis- tics at Columbia University and the Sir Louis Matheson Distinguished Professor at Monash University. Her mo st recent book is Saving Kyoto,coau- thored with K. Sheeran. Stefano Corradin is an economist at Europ ean Central Bank, rese arch division. He earned his B.A. in economics from the University of Verona (1998), his M.Sc. in economics from CORIPE (1999), and his Ph.D. in busi- ness administration from the UniversityofCaliforniaatBerkeley(2008). From 2000 to 2004 he worked in the risk management department of Cattolica Assicurazioni and Allianz-RAS. Jeannine Daniel is an investment analyst at Kedge Capital. Prior to joining Kedge, she worked at Ivy Asset Management, a fund of hedge funds, where she was charged with coordinating the firm’s European research efforts, which included the sourcing and investment due dili gence of manag ers across the various hedge fund strategies. Prior to Ivy, Jeannine worked at Barclays Global Investors and JP Morgan Chase. She hold s a B.Sc. (Hons) in business management from the University of London. Miguel Díaz-Martí nez holds an MBA from the University of Bath and was a Senior Consultant of the National Planning Department of Colombia xxiv Contributor Bios where he analyzed the financial strategies of public companies and advised the National Government in external debt topics. He has also held positio ns a s trader and financial an alyst in firms such as Banco San- tander and ICAP. Miguel holds a Bachelors Degree and a Specialisation Degree in Finance and Internatio nal A ffairs from the Externado University in Colombia, and an International De gree in Political Science from the Institute of Political Studies in Paris. Elena Dukh ovnaya is a consultant at Ernst & Young in Moscow, one of the leading international audit and consulting companies. She graduated from Plekhanov Academy of Economics (Moscow, Russia) with a degree in economics and mathematics in 2005, and also successfully completed 1 year i n the University of Konsta nz (G ermany) on an exchange program. She specializes in business, accounting, and regulatory advisory services to telecommunication and media companies. Mohamed El Hedi Arouri is currently an associ ate professor of finance at the University of Orleans, France, and a researcher at EDHEC Business School. He holds a master’s degree in economics and a Ph.D. in finance from the University of Paris X Nanterre. His research focuses on the cost of capital, stock market integration, and international portfolio choice. He published articles in refereed journals such as Intern ational Journal of Business, Applied Financial Economics, Frontiers of Finance and Economics, Annals of Economics and Statistics, Finance, and Economics Bulletin. Wei Fan obtained his Ph.D. from the University of Electronic Science and Technology of China, Chengdu Nankai University, Tianjin. He is senior vice- president of the fixed-income department at Hong Yuan Securities Co. Ltd. in Beiji ng and is in charge of interest-rate derivatives pricing. He has authored more than 10 academic papers in the International Financial Review, Journal o f Financial Transformation, New Mathematics and Natu ral Computation, Journal of Management (Chinese), and Ope ration and Man age ment (Chinese). In addition, he has been in charge of two National Natu ral Science Founda- tion projects and one Securities Associa tion of China projec t. Hi s re search focuses on asset pricing. Sihai Fan g obtained his Ph.D. in Economics from Naikai University in Tianjing, China. He is a Professor of Finance at the University of Electronic Science and Technology in Chengdu, China. He is a well-known economist in Mainland China and has published over 100 articles. He is Managing Director and Chief Economist of Hongyuan Securities, Co. Ltd., in Beijing. His research area focuses on asset pricing. Contributor Bios xxv [...]... default by creating system-wide risks through a cascading effect where default by one trader leads to default by all, (Chichilnisky and Wu, 2006) We show that graduated reserves dampens limits volatility and restores market equilibrium With the appropriate system of Handbook of Short Selling DOI: 10.1016/B97 8-0 -1 2-3 8772 4-6 .0000 1-5 © 2012, Elsevier Inc All rights reserved 3 4 CHAPTER 1: Short Sales and Financial... or value of the short trade This means that the relative value to the trader of selling short decreases the larger short sale 9 10 CHAPTER 1: Short Sales and Financial Innovation x p y Short sales FIGURE 1.1 Short sales without reserves x Reserves ratio y Short sales FIGURE 1.2 Short sales with fixed reserves ratio x Reserves ratio increases with the size or value of the trade y FIGURE 1.3 Short sales... 19 One Costly Debate—No Shortage of CDS Critics and Advocates 49 Conclusion 53 Acknowledgments 55 References 55 Bibliography 62 Handbook of Short Selling DOI: 10.1016/B97 8-0 -1 2-3 8772 4-6 .0000 2-7 © 2012, Elsevier Inc All rights... degrees from the Swiss Federal Institute of Technology (ETH) and is also a CFA charter holder Kaiguo Zhou is a deputy head and associate professor of the Department of Finance of Lingnan (University) College of Sun Yat-Sun University in China He graduated from City University of Hong Kong with a Ph.D degree in finance in 2003 and served as visiting fellow of Sloan School of Management at MIT in 2006 Zhou... bachelor of art, a bachelor of engineering, and a master of engineering from Tianjin University (China) Grace has published in the Journal of Financial Economics and won the Fama-DFA first prize for the best paper published in 2007 in the Journal of Financial Economics She has served as an ad-hoc reviewer for the Journal of Finance, Journal of Financial and Quantitative Analysis, Journal of Banking... of Missouri He has several working papers in the areas of short selling, mutual funds, and asset pricing and has presented them at the Southwestern Finance Association and the University of Missouri Mario Maggi is an assistant professor of mathematical finance at the University of Pavia He holds a M.S in economics from the University of Pavia and a Ph.D in mathematical finance from the University of. .. out of 4990 academics in the number of articles published during 1990–2002 His co-authored, path-breaking articles on intraday stock market patterns originally published in the Journal of Finance was selected for inclusion in (1) Microstructure: The Organization of Trading and Short Term Price Behavior, which is part of the series edited by Richard Roll of UCLA entitled The International Library of. .. engineering practice of Duff & Phelps, LLC, in the San Francisco office In 2009 she worked in the risk management department of Commerzbank AG in Frankfurt R Deane Terrell is a financial econometrician and officer in the general division of the Order of Australia He served as vice-chancellor of the ANU from 1994 to 2000 He has also held visiting appointments at the London School of Economics, the Wharton... support from Grant No 522 2-7 2 of the U.S Air Force Office of Research and its officer Professor Jun Zhang (Arlington, VA) CCRM Web site: http:// columbiariskmanagement.org/ REFERENCES Chichilnisky, G (1991, 1995) Limited arbitrage is necessary and sufficient for the existence of competitive equilibrium with or without short sales Discussion Paper No 650, Columbia University Department of Economics, December... introduction of an appropriate system of graduated reserves that reduces the likelihood of default and restores the market equilibrium in markets with short sales We show rigorously how graduated reserves dampen the incentives for taking large short- term positions and help stabilize short sales Markets with short sales as defined here differ from Arrow–Debreu markets in that traders have no bounds on short . Congress Cataloging-in-Publication Data Gregoriou, Greg N., 195 6- Handbook of short selling / Greg N. Gregoriou. p. cm. ISBN 97 8-0 -1 2-3 8772 4-6 1. Short selling. 2. Speculation. 3. Risk-taking (Psychology). Handbook of Short Selling Handbook of Short Selling Greg N. Gregoriou Editor AMSTERDAM • BOSTON • HEIDELBERG • LONDON NEW YORK. better understand short selling during and after the crisis of 2008. The 39 chapters in this handbook will be a valuable source of information to anyone interested in short selling. Among its