I really shouldn’t have a go at academics since that was a career path I once aspired to. Despite my failed career aspirations they do always seem to be late to the party and when they get there they have brought Captain Obvious as a date. As an example consider the abstract from this piece I recently came across.
We examine the causal effect of limits to arbitrage on 11 well-known asset pricing anomalies using Regulation SHO, which relaxed short-sale constraints for a random set of pilot stocks, as a natural experiment. We find that the anomalies became weaker on portfolios constructed with pilot stocks during the pilot period. Regulation SHO reduced the combined anomaly long-short portfolio returns by 72 basis points per month, a difference that survives risk adjustment with standard factor models. The effect comes only from the short legs of the anomaly portfolios.
The full article can be found here. Long story made short is that short selling provides a valuable price discovery function and this function dampens down systems. This is something that has been known by traders for generations which is why the banning of short selling during the GFC simply made matters worse. There is a fundamental disconnect between the reality of trading and the academic and regulatory interpretation of how markets should work in a bubble. Unfortunately, too many traders get sucked into the complexities of academia and think that such intricacies are the ticket to their salvation. As always we come back to the notion that trading is a simple affair that is driven not by what the market does but by your reaction to it.
