[THE VIEW]Short Selling, Beneficial for Stock Prices in the Long Term

Despite Short-Term Price Declines,
Short Selling Plays a Positive Role
by Correcting Overvalued Stocks in the Market

Recently, Lee Bok-hyun, the Governor of the Financial Supervisory Service, mentioned at an event his hope for the resumption of short selling in June. The Presidential Office dismissed this notion. Earlier, on the 13th, individual investors in the United States flocked again to GameStop shares, driving the stock price up by 74% in a single day, reminiscent of the meme stock surge and short selling episodes of 2020-2021. At that time, some individual investors analyzed that certain hedge funds were undervaluing these stocks through short selling, leading to an undervaluation of the stock prices. They encouraged individual investors to push hedge funds into a short squeeze and protect the companies, which ultimately led to the bankruptcy of Melvin Capital, a representative of the short selling forces.

So why is short selling currently banned, and why do some investors express dissatisfaction with it? First, it is argued that it is difficult to completely prevent illegal naked short selling. Naked short selling, which involves short selling without borrowing stocks in advance and thus without collateral, poses a risk of market disruption and is regulated worldwide. However, in Korea, short selling has not been computerized, making strict monitoring difficult. In April, financial authorities already unveiled a computerized system. If this system functions effectively in monitoring, illegal naked short selling can be prevented.

Second, there is an unfair regulation between institutional investors and individual investors. Individual investors are not prohibited from short selling. However, the supply of stocks available for lending for short selling is limited, and only margin trading with relatively high interest rates is possible, whereas institutions can engage in relatively advantageous securities lending transactions.

Third, do institutions using short selling only profit? On the contrary, short selling often carries greater risks. When buying stocks, the worst-case loss is 100%, but with short selling, since there is no upper limit on the stock price, potential losses are unlimited.

Lastly, there is an argument that short selling, due to the burden of stock price declines, actually fuels the "Korea Discount" (undervaluation of Korean stocks). Generally, the claim that short selling exerts downward pressure on stock prices is not incorrect. Market prices are usually determined by supply and demand, and short selling acts similarly to creating "negative" demand, which can lower prices. However, this can also help in proper asset valuation. Without short selling, many investors could raise stock prices through buy orders, but this is limited because only those holding stocks can sell them. Therefore, opinions expecting stock price declines may not be reflected in prices, resulting in an imbalance where only positive opinions are reflected.

In conclusion, short selling can negatively affect stock prices, but since this may represent a correct valuation, it cannot be seen as having a detrimental effect on the market. Implementing short selling immediately may negatively impact stock prices, but it can correct overvalued prices and ultimately benefit stock prices in the long term. However, banning short selling due to the burden of short-term price declines is likely a shortsighted and political decision.

Park Sung-kyu, Professor at Willamette University, USA