Question

Why does it matter for financial markets if people can or cannot short-sell shares?

Answer 1

Short selling of a stock happens when investor thinks that the price of the stock is going to decline in near future. The investor borrows the stock and sells it at high price and when the price of stock decline; investor close the position by buying the stock back and returning the borrowed stock. The difference in the selling price and purchase price at the time of closing the position is the profit of investor but if the price at the time of closing the position is more than the selling price then the investor makes a loss.

Short selling provides liquidity in financial market as people can short-sell shares even if they do not hold it. If short selling will not be allowed then liquidity will reduce in financial market. Short selling is used a hedging tools so if people cannot short-sell shares then they will not be able to use it for hedging in financial market.