The first study of the impact of the SEC's July 15 emergency order restricting short selling in nineteen financial stocks shows that the order probably had a detrimental effect on markets. While the order was in effect, the bid-offer spreads in the protected stocks widened and the stocks became more correlated with broader market movements.

The study comes from Arturo Bris, a professor at Lausanne's IMD business school. He finds that volatility in the 19 stocks decreased while bid-offer spreads increased, while both measures remain stable for non-protected stocks. This suggests that the SEC order was genuinely interfering with market pricing. What's more, overall market efficiency was harmed by the market. In an efficient market, stocks move less with broader indexes and more on information about individual firms. While the order was in effect, the prices of the 19 firms became more correlated with the broader markets.

Perhaps more interestingly, the study also questions the widespread impression that the 19 financial stocks were being victimized by naked short-selling. The average ratio of short sales to overall trading in the 19 stocks was only one tick higher than for other financial companies, for instance. Prior to the order, the largest volume of shorting activity hit firms that were issuing convertible bonds. This implies that most of the short sales in these stocks were not done by rumor-mongering speculators but by convertible bond arbitrage funds.

The cynical will hardly be gob-smacked by the report. Of course the emergency order made the markets less efficient and interfered with pricing, they'll say. Isn't that what it was intended to do?

(via Seeking Alpha)