Market-Maker Short Selling: A Necessary Evil?

This paper investigates the impact of market-makers’ short-selling activities, focusing on the single-stock futures (SSFs) market in Korea during the short-selling ban (March to April 2021), when only market makers were permitted to sell the underlying stocks short. Employing supervised and unsupervised machine-learning techniques, we classified marketmakers’ short-selling activities into three categories—aggressive, reluctantly compliant, and willingly compliant—and applied overlap propensity-score weighting to mitigate confounding biases. Our results reveal that SSFs market-makers’ aggressive short selling significantly improved liquidity, reduced volatility, and enhanced price efficiency, which is remarkable given the restrictive regulations that limited short-selling volumes. However, these short-selling activities did not alleviate the backwardation effect in the spot markets, suggesting that the regulatory restrictions limited SSFs market makers from fully realizing the benefits of short selling. This study is the first to empirically examine the economic role of short-selling activities conducted by SSFs market makers and their influence on market quality in futures and spot markets. Our findings emphasize the need for flexible regulations that fully harness the crossmarket benefits of their short selling, while minimizing the risk of market and political abuses.