Let Data, Not Politics, Guide Regulation

by Tobias J. Moskowitz

Bloomberg
May 24, 2012

Several years after the global financial crisis, the fierce debate over regulation continues to be driven by strong beliefs -- largely uninformed ones -- rather than hard facts.

Some believe more regulation is necessary, others that it would cause the downfall of our markets. No one, however, seems to be talking about the evidence for or against regulation.

This is partly because very little evidence exists on the effects of regulation or its efficacy. It is extremely difficult to isolate the impact of any proposed regulatory change from everything else that is occurring simultaneously within financial markets. Studies claiming to analyze those effects are almost always confounded by other factors, such as the environment that led to a given regulation; the response of market participants to regulation or anticipated regulation; the selection of securities targeted for regulation; and the timing of regulation.

To overcome these problems and identify an effect unrelated to other possible effects, it would be useful to run a controlled experiment, as medical research does with clinical trials. Is that feasible in financial markets? My colleagues Steven Kaplan, Berk Sensoy and I recently conducted such an experiment to get a better understanding of one type of financial regulation: bans on short selling certain stocks, a very simple measure that was put in effect worldwide for financial stocks during the crisis.

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