[Viewpoint] Resumption of Short Selling and KOSPI 3300

Professor Hee-Jun Ahn, School of Business, Sungkyunkwan University

Short selling, which was fully banned on March 16 last year due to the sharp stock market crash caused by COVID-19, resumed on May 3 after about one year and two months. Contrary to some concerns that the stock market would plunge, the KOSPI index last week surpassed the 3,300 mark for the first time ever, maintaining a robust upward trend.

Based on numerous domestic and international studies, academia has expressed the view that short selling has more positive functions than negative ones, and that the authorities’ well-prepared resumption of short selling contributes to healthy market development. Although some still advocate for a complete ban on short selling, the fact that the shock from its resumption was not significant is, in a way, a predictable outcome. Of course, short selling was resumed only for the stocks included in the KOSPI 200 and KOSDAQ 150 indices, but considering that the market capitalization of these 350 stocks accounts for 80% of the entire stock market, the results would likely not have been much different even if short selling had been fully implemented.

The most essential function of the market is price discovery. This function is maintained efficiently when information is reflected in stock prices immediately and freely through orders and trades. Stock prices fluctuate frequently as they incorporate positive and negative information. Artificially restricting the flow of information in one direction can hinder the price discovery function. If short selling is constrained, negative information may not reach the market in time, causing stocks to be overvalued. While overvaluation may initially benefit investors holding the stocks, the nature of the market means that prices will eventually fall. If the delayed decline is suddenly reflected in stock prices all at once, the impact can be much greater.

During crises such as the early 2000s dot-com bubble, the 2008 global financial crisis, and the 2013 European debt crisis, short selling attracted significant attention, and academia actively studied the effects of government-imposed bans or restrictions on short selling. Most of these studies provide clear evidence that imposing constraints on short selling tends to produce negative rather than positive outcomes for the market. Based on these lessons, many advanced stock markets, including the United States, either maintained short selling during the COVID-19 crisis or limited it only for a relatively short period.

Recently, I researched the effects of short selling restrictions implemented in various Asian countries during COVID-19. Asian countries responded to short selling in diverse ways. South Korea, Malaysia, and Indonesia banned short selling, while Taiwan and Thailand restricted it by strengthening the uptick rule. Singapore, Japan, China, and Hong Kong maintained short selling as usual. The analysis generally confirmed that banning or restricting short selling increased stock price volatility, reduced price discovery functions and liquidity, and overall deteriorated market functions. This aligns with the 2013 study by Alessandro Beber and Marco Pagano, which found that short selling restrictions imposed by governments during the global financial crisis worsened market quality. Such deterioration of market functions is unlikely to benefit investors in the long term.

Short selling regulations have consistently sparked debate in South Korea. Especially during the COVID-19 pandemic, more social discussions took place than ever before. Through this process, market participants’ understanding of short selling improved, and regulatory enhancements were implemented by the authorities. I believe this has prepared the market to face short selling regulations more maturely than before. All of this can be seen as growing pains and part of the market’s maturation process.

This content was produced with the assistance of AI translation services.