The Effectiveness of the Uptick Rule and the Naked Short-Selling Ban: an Agent-Based Simulation

Abstract

There are substantial discussions on the pros and cons, from regulators, market participants and academics, regarding the introduction of regulated short selling. In this research, we focus on two of the four regulatory measures on short- selling in Japan: "uptick rule requirement" and "naked short-selling ban." We analyze the effectiveness of each measure by comparing the simulations for markets with and without the regulation. The unique feature of our model is the stock lending and borrowing transactions between traders. The lending/borrowing fee is modeled to influence the investment decisions of the traders. We calculate the price fluctuation, divergence of the price from the fundamental value and price volatility for each simulated market. We evaluate robustness of the markets by giving an exogenous shock to the markets causing drastic declines in the fundamental price. As a result, we find that both regulatory measures make the market more stable and robust against abrupt shocks to the market.