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What's the problem with it, really? If A promises B to sell him something and then A can't deliver for some reason, then B will stand to be compensated by A for
by roel_v 14y ago
What's the problem with it, really? If A promises B to sell him something and then A can't deliver for some reason, then B will stand to be compensated by A for any damages resulting from that. Why would it be special for stock? Of course there is the risk that massive naked trades will influence the price of stocks, but that should just be priced in, like any other risk, no? What am I missing?
- joe_the_user 14y agoUh, The risk of massive short sales are not to the naked short-sellers. Thus the market does not work as an automatic way system taking this into account. Moreover, the hypothetical that the market prices in bad behavior is not a justification for bad behavior.
- quantgenius 14y agoThe risk of massive short sales are precisely to the naked short-sellers because you can be required to deliver at any time and if you fail to deliver you broker or the DTC can buy you in at any price, and charge you an enormous commission on that specific trade.
- joe_the_user 14y agoAll this does hinge on whether an entity is going to be heavily penalized for failure to deliver. Can you reference me instances of such penalities being applied? I searched for instance and instead found this: http://www.billcara.com/archives/2006/09/a_failure_to_de.html http://www.billcara.com/archives/2006/09/a_failure_to_de.htm...
- roel_v 14y agoNo, it hinges on entities being held to the same standard as any other contracting party in the economy. Party A agrees to do something for party B in exchange for a sum of money, party A doesn't hold up its end of the deal, now B has a claim on A for damages suffered because of A not doing what they promised. (technically the law is more nuanced, of course - there is a whole field in law dealing with the subtleties of this, but this is what it comes down to, and it's the same whether it's for stock or grain or a wedding dress).
- Yrlec 14y agoWhen you're selling something you don't own you're distorting the market's price discovery mechanisms. In many contexts I think most people would consider it fraudulent to sell something before you've bought it.
- impldefined 14y agoBut doesn't there need to be a way to bet that something is overpriced?
- cynicalkane 14y agoI've never got the impression that most economists think short selling distorts the market's price discovery mechanisms, and it's really dishearting that the GP is being downvoted for, plainly and clearly, stating what is economic orthodoxy. Anyway, the futures market has functioned for centuries with people buying and selling what they don't own, and the big institutional buyers and sellers commonly use futures prices as their benchmark prices. It looks like the smart money isn't too concerned about negative effects on price discovery. Also, let's not confuse playing by the clearly established rules of the market with "fraud". Moral objection is no excuse for equivocation.
- Yrlec 14y agoNormal short selling doesn't distort price discovery. Khan Academy describes this quite well: http://www.youtube.com/watch?v=zAkMhEqWFF0 http://www.youtube.com/watch?v=zAkMhEqWFF0. However, with naked short selling it's a different story. When you're short selling something that you don't own you're in effect making it look like the supply is bigger than it actually is. This distorts the price discovery mechanism.
- cynicalkane 14y agoNaked short interest is almost certainly too ephermal to distort the price, but suppose it does due to illusory oversupply. So what's the objection? If you buy, hold, and sell, you want prices to be overall lower. Selling low isn't bad if it means you were also buying low. In short, as Warren Buffet likes to point out, low prices are good for investors.