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It took just one day for the euphoria to wear off. News of a short selling ban in South Korea on Monday sparked a 6 per cent jump in the country’s benchmark Kospi index, the most in more than three years. The next day a sharp share price reversal triggered a circuit breaker. That should not surprise. Short selling bans historically have had little lasting impact on market activity.

Korean regulators ordered a full ban on short selling — the first such restriction in three years — that will last through June.

Hopes abound for this blunt policy instrument in Korea. Retail investors count on the ban to encourage short covering to boost stock prices. Politicians yearn to win favour from voters.

During the 2008 financial crisis US regulators banned the short selling of financial stocks, for just over two weeks. That did little to stabilise markets. A previous prohibition had the opposite effect in 1932, sparking a market drop of more than 50 per cent.

Short trading bans often curtail trading liquidity, pushing bid to offer spread costs up. The Federal Reserve estimated that extra trading expenses resulting from the US ban in 2008 were more than $1bn.

The timing of Korea’s prohibition is peculiar. Although down since midsummer, Korea’s Kospi index is up this year. Without a looming crisis, one suspects that the latest restrictions have a political angle. National legislature elections are coming in April. Market curbs are often welcomed by retail investors who sometimes see short sellers as vultures in the market.

It is true that nearly all short selling is done by foreign and institutional investors. But the practice is hardly pervasive there. Of total market value, short selling activity accounts for less than 1 per cent of the local market turnover.

These curbs complicate hedging processes. That can dent confidence in Korea’s equity market and deter capital market activity. Institutional investors turned net sellers of Korean stocks on Tuesday. Shares in electric vehicle battery parts company Ecopro Materials, the country’s second-largest listing this year, priced the same day at the bottom of its marketed range.

Short sellers contribute to market liquidity and effective price discovery. Keeping markets as open as possible is the best way to enhance their efficiency.

Are short sellers really vultures to be tamed? Or is hedging an important part of the market’s efficient operation? Please tell us what you think in the comments section below.

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