The Effect of Short Selling Regulation SHO on Informational Efficiency

The short selling regulation of 2005 (regulation SHO), and its more restrictive version of 2008, was put in place to curb potentially manipulative naked short selling. However, this regulation has been criticized in the literature for reducing market quality. Contrary to other findings, I show that this regulation deters uninformed traders, and improves the informativeness of naked short sellers. In particular, after 2008, the aggregate naked short selling activity has increased in information content, and has become significantly connected to the percentage of net short positions in the E-Mini stock index futures markets. Consistent with the increased informativeness of naked short sellers, I find that the market views excessive and persistent naked short selling activity as a bearish signal only after 2008