Predatory short sales and bailouts
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Date
2017
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Abstract
This paper extends the literature on predatory short selling and bailouts
through a joint analysis of the two. We consider a model with informed short
sales, as well as uninformed predatory short sales, which can trigger the inefficient
liquidation of a firm. We obtain several novel results: A government commitment
to bail out insolvent firms with positive probability can increase welfare because
it selectively deters predatory short selling without hampering desirable informed
short sales. Contrasting a common view, bailouts can be optimal ex ante but
undesirable ex post. Furthermore, bailouts in our model are a better policy tool
than short selling restrictions. Welfare gains from the bailout policy are unevenly
distributed: shareholders gain while taxpayers lose. Bailout taxes allow ex-ante
Pareto improvements.
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Keywords
government bailouts, short sale bans, predatory trading, short sales