Short selling and the independence of business-related analysts: Evidence from an emerging market

This paper investigates whether short-sale deregulation improves analysts' independence in an emerging market where conventional mechanisms mitigating conflicts of interest are either ineffective or absent. Short selling reduces the effectiveness of analysts' favourable opinions in creating or sustaining overvalued stock prices, thus decreasing the incentives of institutional clients of brokerages to exert pressure on related analysts to initiate coverage and issue biased opinions. Using a difference-in-difference approach, we find strong evidence that stocks that are eligible for short sales experience a greater reduction in coverage by related analysts than stocks that are ineligible for short sales. When covered firms become eligible for short sales, the quality of forecasts and recommendations issued by related analysts improves considerably. Further analyses show that shortable firms with a significant reduction in related analysts' coverage are more likely to underperform and to experience stock price crashes in the future. Altogether, our results are consistent with short selling effectively restoring related analysts' independence in emerging markets.     

Pricing deviation,misvaluation comovement,and macroeconomic conditions

We measure an individual stock’s misvaluation based on the deviation of its price from predicted intrinsic value. Both under- and overvalued stocks identified by this misvaluation measure exhibit greater valuation uncertainty and arbitrage difficulty, and the misvaluation measure strongly predicts stock returns incremental to size, book-to-market ratio, past returns, and various return anomalies. Based on the misvaluation measure, we form a misvaluation factor and find that stock return covariances with this factor possess significant and robust return predictive power. We further show that the misvaluation factor predicts future economic conditions, providing additional insight into the real effect of systematic misvaluation in the stock market.     

Do arbitrageurs amplify economic shocks?

We test the hypothesis that arbitrageurs amplify economic shocks in equity markets. The ability of speculators to hold short positions depends on asset values. Shorts are often reduced following good news about a stock. Therefore, the prices of highly shorted stocks are excessively sensitive to shocks compared with stocks with little short interest. We confirm this hypothesis using several empirical strategies including two quasi-experiments. In particular, we establish that the price of highly shorted stocks overshoots after good earnings news due to short covering compared with other stocks.     

Are Short Sellers Informed? Evidence from the 2007–2008 Subprime Mortgage Crisis

This paper examines the short selling activities around financial firms’ announcements of asset write‐downs during the 2007–2008 subprime mortgage crisis. We find that short sellers accumulate short positions prior to write‐down announcements, and that stocks experience significantly negative returns around such announcements. These results suggest that the return predictability of short interests is due to short sellers’ informational advantage. Furthermore, we show that short sellers increase their positions significantly in the announcement month and keep increasing their positions afterward, suggesting the feedback effect of the disclosed write‐downs on financial firms’ existing exposures. The valuable information contained in the short interest should encourage regulators to mandate stock exchanges disclose short selling activities more frequently.     

Are extreme returns priced in the stock market? European evidence

This paper revisits some recently found evidence in the literature on the cross-section of stock returns for a carefully constructed dataset of euro area stocks. First, we confirm recent results for US data and find evidence of a negative cross-sectional relation between extreme positive returns and average returns after controlling for characteristics such as momentum, book-to-market, size, liquidity and short term return reversal. We argue that this is the case because these stocks have lottery-like characteristics, which is attractive to certain investors. Also, these stocks tend to be very volatile so that arbitrageurs are discouraged from correcting potential mispricing. As a consequence, these stocks are often overpriced and hence face lower expected returns. Second, when we control for extreme returns, the recently found negative relationship between idiosyncratic risk and future returns is less robust. In our models, after adding maximum returns, the relationship is insignificant and sometimes even positive. We also find that idiosyncratic skewness and coskewness play an important role for asset pricing, as predicted by several theoretical models.     

Is Gold a Hedge or a Safe Haven? An Analysis of Stocks,Bonds and Gold

Is gold a hedge, defined as a security that is uncorrelated with stocks or bonds on average, or is it a safe haven, defined as a security that is uncorrelated with stocks and bonds in a market crash? We study constant and time‐varying relations between U.S., U.K. and German stock and bond returns and gold returns to investigate gold as a hedge and a safe haven. We find that gold is a hedge against stocks on average and a safe haven in extreme stock market conditions. A portfolio analysis further shows that the safe haven property is short‐lived.     

The good news in short interest

Stocks with relatively high short interest subsequently experience negative abnormal returns, but the effect can be transient and of debatable economic significance. In contrast, relatively heavily traded stocks with low short interest experience both statistically and economically significant positive abnormal returns. These positive returns are often larger (in absolute value) than the negative returns observed for heavily shorted stocks. Thus, the positive information associated with low short interest, which is publicly available, is only slowly incorporated into prices, which raises a broader market efficiency issue. Our results also cast doubt on existing theories of the impact of short sale constraints.     

Short Sales Constraints and Momentum in Stock Returns

Abstract:   We show that stock characteristics identified by D'Avolio (2002) provide a reliable index of the mostly unobservable short sales constraints. Specifically, we find that this index is positively related to the level of short interest and to short selling costs implied by the disparity in prices in the options and stock markets, and is negatively related to future returns. Using this index, we show that the magnitude of momentum returns for the period 1984 to 2001 is positively related to short sales constraints, and loser stocks rather than winner stocks drive this result. We conclude that short sales constraints are important in preventing arbitrage of momentum in stock returns.     

Daily short interest,idiosyncratic risk,and stock returns

This paper examines the relation between short selling and returns and the impact of arbitrage costs on short sellers’ behavior. Using daily UK short selling data, we find that stocks with low short interest levels experience significant positive returns on both an equal- and value-weighted basis. Economic theory predicts that short sellers avoid establishing positions in stocks with high idiosyncratic risk. Our results indicate a negative relation between short interest and returns among high idiosyncratic risk stocks and that short selling activity is mostly concentrated in low idiosyncratic risk stocks where it is less costly to arbitrage fundamental risk.     

The 2008 short sale ban: Liquidity, dispersion of opinion, and the cross-section of returns of US financial stocks

This study examines the cross-sectional impact of the 2008 short sale ban on the returns of US financial stocks. Motivated by the large cross-sectional variation in the extent to which banned stocks suffer an illiquidity shock, we hypothesize that stocks with larger liquidity declines are associated with poorer contemporaneous stock returns. The evidence supports this hypothesis and suggests that this effect is stronger for more liquid stocks, as predicted by Amihud and Mendelson (1986). Moreover, consistent with Miller’s (1977) model, we report a valuation reversal whereby stocks with higher abnormal returns at the onset of the ban have lower abnormal returns at its removal. Our findings are robust when we control for firms most affected by TARP, include non-banned matched firms, and compare banned firms’ stock returns with their bond returns. From a policy standpoint, the ban reduced valuations, ceteris paribus, of the stocks that were hardest hit by illiquidity.