Short-sale inflow and stock returns: Evidence from Japan

Using a 10-year panel of flow-based information on stock borrowings and constructing a flow-based measure for shorting demand, I examine the relation between shorting demand and subsequent stock price movements. I find that the least heavily shorted stocks tend to outperform the most heavily shorted stocks and that this outperformance persists up to three months. In addition, using proxies for information asymmetry derived from the market microstructure literature, I find that this outperformance is not confined to stocks with high information asymmetry. These empirical findings indicate that short sellers act not only as informed investors who gain negative news but also as skillful investors who detect stock price deviations from fundamental values.     

Which Shorts Are Informed?

We construct a long daily panel of short sales using proprietary NYSE order data. From 2000 to 2004, shorting accounts for more than 12.9% of NYSE volume, suggesting that shorting constraints are not widespread. As a group, these short sellers are well informed. Heavily shorted stocks underperform lightly shorted stocks by a risk‐adjusted average of 1.16% over the following 20 trading days (15.6% annualized). Institutional nonprogram short sales are the most informative; stocks heavily shorted by institutions underperform by 1.43% the next month (19.6% annualized). The results indicate that, on average, short sellers are important contributors to efficient stock prices.     

Short selling and stock returns: Evidence from the UK

The practice of shorting stocks was put forward as one of the causes of the recent financial crisis whereas Shiller (2003), for example, considers shorting an essential element of an efficient market. Shorting involves selling borrowed stocks and subsequently closing the position by purchasing and returning the stock to the lender. A profit will be realised if the stock's price decreases. Shorting enables investors who do not own a perceived overvalued stock to sell. Using a high-frequency UK dataset for the period between September 2003 and April 2010, our findings suggest shorting indicates evidence of overvalued stocks as significantly negative abnormal stock returns appear to follow an increase in shorting. These results do not hold, however, for shorting which occurs around the ex-dividend date. We further find that these results hold during the recent financial crisis.     

Against the tide: the commencement of short selling and margin trading in mainland China

China's recent removal of short‐selling and margin trading bans on selected stocks enables testing of the relative effect of margin trading and short selling. We find the prices of the shortable stocks decrease, on average, relative to peer A‐shares and cross‐listed H‐shares, suggesting that short selling dominates margin trading effects. Contrary to the regulators' intention and recent developed market empirical evidence, liquidity declines and bid‐ask spreads increase in these shortable stocks. Consistent with Ausubel (1990), these results imply that uninformed investors avoid the shortable stocks to reduce the risk of trading with informed investors.     

Time-dependent lottery preference and the cross-section of stock returns

Highlighting the importance of benchmark to identify lottery-like payoffs of stocks, this study proposes that investors’ lottery preference is formed toward tracking stocks’ performance over time. Accordingly, we develop a strategy based on time-dependent maximum daily return (denoted as TMAX) by buying (short selling) stocks with the most recent maximum daily returns (MAX) ranked in the bottom (top) decile of the historical distribution. The TMAX strategy generates significant premium that subsumes the profitability of Bali, Cakici, and Whitelaw’s (2011) MAX strategy, but not vice versa. A major advantage of the TMAX strategy is its time-invariant profitability across different periods and sentiment states. Further analyses show that the TMAX premium can be explained by shorting flow and behavioral theories, supporting the time-dependent feature of lottery preference.     

Short Interest and Lottery Stocks

We find short interest‐related mispricing is strongest in lottery stocks. As stocks become more lottery‐like, arbitrage risk increases, resulting in higher overpricing (underpricing) in high (low) relative short interest (RSI) stocks. Monthly portfolio alphas are –1.61% for high RSI lottery stocks, whereas high RSI stocks with the least lottery‐like attributes show statistically insignificant alphas. Among lightly shorted stocks, lottery securities exhibit monthly alphas of 1.80%. Thus, although lottery stocks as a group typically underperform, investors can earn positive abnormal returns in lightly shorted lottery stocks. Our results suggest that lottery stocks’ greater noise trader risk and higher transactions costs impedes arbitrage in short interest‐related mispricing.     

Mandatory Portfolio Disclosure,Stock Liquidity,and Mutual Fund Performance

We examine the impact of mandatory portfolio disclosure by mutual funds on stock liquidity and fund performance. We develop a model of informed trading with disclosure and test its predictions using the May 2004 SEC regulation requiring more frequent disclosure. Stocks with higher fund ownership, especially those held by more informed funds or subject to greater information asymmetry, experience larger increases in liquidity after the regulation change. More informed funds, especially those holding stocks with greater information asymmetry, experience greater performance deterioration after the regulation change. Overall, mandatory disclosure improves stock liquidity but imposes costs on informed investors.     

Arbitrage Asymmetry and the Idiosyncratic Volatility Puzzle

Buying is easier than shorting for many equity investors. Combining this arbitrage asymmetry with the arbitrage risk represented by idiosyncratic volatility (IVOL) explains the negative relation between IVOL and average return. The IVOL‐return relation is negative among overpriced stocks but positive among underpriced stocks, with mispricing determined by combining 11 return anomalies. Consistent with arbitrage asymmetry, the negative relation among overpriced stocks is stronger, especially for stocks less easily shorted, so the overall IVOL‐return relation is negative. Further supporting our explanation, high investor sentiment weakens the positive relation among underpriced stocks and, especially, strengthens the negative relation among overpriced stocks.     

Are Short Sellers Informed? Evidence from REITs

This paper uses intraday short sale data to examine whether short sellers of Real Estate Investment Trusts (REITs) are informed. We find strong evidence that short selling predicts future returns of REITs. Heavily shorted REITs significantly underperform lightly shorted REITs by approximately 1% over the following 20 trading days. This predictive relation holds for both small and large trades, but is stronger for large short trades. We also document a positive relation between shorting activity and volatility. Our results are consistent with the view that short sellers of REITs are informed and contribute to market efficiency by impounding information into prices.     

Tax management strategies with multiple risky assets

We study the consumption-portfolio problem in a setting with capital gain taxes and multiple risky stocks to understand how short selling influences portfolio choice with a shorting-the-box restriction. Our analysis uncovers a novel trading flexibility strategy whereby, to minimize future tax-induced trading costs, the investor optimally shorts one of the stocks (or equivalently, buys put options) even when no stock has an embedded gain. Alternatively, an imperfect form of shorting the box can reduce aggregate equity exposure ex post. Given these two short selling strategies, it is common for an unconstrained investor to short some equity while a constrained investor holds a positive investment in all stocks. With no shorting, the benefit of trading separately in multiple stocks is not economically significant.     

Short Selling and the Weekend Effect in Nasdaq Stock Returns

We examine daily short selling of Nasdaq stocks to explore whether speculative short selling causes a significant portion of the weekend effect in returns. We identify a weekend effect in speculative short selling whereby it constitutes a larger percentage of trading volume on Mondays versus Fridays. We find an opposite effect in dealer short selling, consistent with market makers adding liquidity and stability. Our main finding is that speculative short selling does not explain an economically meaningful portion of the weekend effect in returns, even among the firms most that are most actively shorted. This finding contradicts some prior studies.     

The 2011 European short sale ban: A cure or a curse?

This paper examines whether the 2011 European short sale ban on financial stocks proved to be successful or had a negative impact on financial markets. We explicitly take an options market perspective and focus on market participants’ changes in beliefs and expectations. During the ban, short positions in banned stocks decreased, whereas they increased for non-banned stocks. Our results indicate that the ban increased implied jump risk levels, thereby negatively impacting the banned financial stocks. However, we also observe that after the announcement of the ban, financial contagion risk actually dropped for banned stocks. Instead of a substitution effect between regular short selling and synthetic shorting through single stock puts, we observe a migration out of single stock puts into the EuroStoxx 50 index options market. We conclude that this type of migration diversified selling pressure initially concentrated in financial stocks across a larger share of the stock market, thereby reducing systemic risks and enhancing overall financial stability.     

中国式卖空机制与高管减持——基于融资融券分步扩容的准自然实验

本文以我国的融资融券制度为背景,结合双重差分模型,研究卖空机制对上市公司高管减持行为的影响。研究发现,相对于非融券标的,可融券标的公司高管的月减持比例在允许卖空后下降22%,这种抑制作用在小规模、高盈余平滑度以及非国有公司中体现得更为明显。其次,成为可融券标的后,股价定价效率提高,高管减持收益显著下降。进一步地,本文将高管的减持行为分为定期性与投机性两类,发现卖空机制显著抑制了高管基于信息优势和股价偏差的投机性减持行为。     

Which financial stocks did short sellers target in the subprime crisis?

Tracing the SEC ban on the short selling of financial stocks in September 2008, this paper investigates whether such selling activity before the 2008 short ban reflected financial companies’ risk exposure in the subprime crisis. Evidence suggests that short sellers sold short stocks that had the greatest asset and insolvency risk exposures, and that the short selling of financial firms’ stocks was not significantly greater than that of non-financial firms after we match them on firm size and insolvency risk. When the short ban was in effect, the market quality of financial stocks without subprime assets exposure had deteriorated to a larger degree than that of financial companies with subprime assets exposure. The findings imply that such a regulation may mute the market disciplining effects of investors and may also be seen as a counterweight to any perceived macro or systemic risk reduction benefits resulting from such a ban.     

Short-sale refinancing and price adjustment speed to bad news: Evidence from a quasi-natural experiment in China

Short selling may accelerate stock price adjustment to negative news. However, the literature provides mixed evidence for this prediction. Using short-sale refinancing and a staggered difference-in-differences (DID) model, this paper explores the effect of short selling on stock price adjustment. Our results show that (1) short-sale refinancing improves the speed of stock price adjustment to negative news. This result holds after we control for endogeneity. (2) The positive relationship between short-sale refinancing and stock price adjustment speed is significant in subsamples of stocks with higher earnings management or lower accuracy of analyst forecasts, indicating that firms with more opaque information are more likely to be targeted by short sellers. In subsamples of stocks with a higher ownership concentration or lower ownership by institutional investors, short selling is more likely to increase the speed of stock price adjustment, indicating that ownership structure may influence negative news mining. (3) As short-sale refinancing exacerbates the absorption of bad news by stock prices, it increases crash risk. This study enriches the research on the economic consequences of short selling and provides empirical evidence supporting regulations on short selling in China.     

Short-Selling Prior to Earnings Announcements

This paper examines short‐sales transactions in the five days prior to earnings announcements of 913 Nasdaq‐listed firms. The tests provide evidence of informed trading in pre‐announcement short‐selling because they reveal that abnormal short‐selling is significantly linked to post‐announcement stock returns. Also, the tests indicate that short‐sellers typically are more active in stocks with low book‐to‐market valuations or low SUEs. The levels of pre‐announcement short‐selling, however, mostly appear to reflect firm‐specific information rather than these fundamental financial characteristics. We believe that these results should encourage financial market regulators to consider providing more extensive and timely disclosures of short‐selling to investors.     

The tax-loss selling hypothesis,market liquidity,and price pressure around the turn-of-the-year

In this paper, we use intra-day data for all stocks listed on the ISSM and provide new and direct evidence consistent with the tax-loss selling hypothesis. We find that (a) there is abnormal selling pressure prior to the year-end for stocks that have experienced large capital losses in the current and prior years (b) investors delay realizing capital gain by postponing the sale of capital gain stocks until after the new year (c) there is a significant decrease in the average trade size for stocks with large capital losses before the year-end and for stocks with capital gains in the new year, which suggests that individuals, rather than institutional investors, are the major sellers around the year-end (d) the tax-loss selling hypothesis, and not firm size or share price, is the fundamental explanation for abnormal January returns. Further, small or low share priced firms with capital gains do not experience abnormal returns in January. However, conditional on capital losses, small or low share priced firms magnify the turn-of-the-year effect (e) On average, the increase in selling activity adversely affects market liquidity by increasing bid-ask spreads and reducing depths. (f) The tax-loss selling pressure not only causes the price to be at the bid at the year-end, it also temporarily depresses the equilibrium price indicating the short run demand curve is not perfectly elastic (g) the year-end buying activity suggests that large investors buy capital loss stocks prior to the year-end to take advantage of the temporarily depressed price and capital gain stocks after the new year to reinvest the proceeds of the tax-loss selling.     

Short Selling Behavior and Mad Money

We examine 1,234 buy recommendations from Jim Cramer's Mad Money television show. Consistent with prior research, we report positive abnormal returns immediately after buy recommendations, followed by a reversal, indicative of an overpricing event. We also find a marked increase in short selling. Our results show a positive association between shorting and the buy recommendations even after controlling for factors shown in the literature to influence shorting. We do not find similar effects after sell recommendations. These results suggest that short sellers act to exploit short‐term overpricing arising from behavioral biases of some investors.     

Does short selling improve stock price efficiency and liquidity? Evidence from a natural experiment in China

China introduced short selling for designated stocks in March 2010. Using this important policy change as a natural experiment, we examine the effect of short selling on stock price efficiency and liquidity. We show that the introduction of short selling significantly improves price efficiency, as measured by the differences in individual stock responses to market returns and the delay in price adjustments. Short selling also enhances stock liquidity, as measured by bid-ask spread and Amihud [2002. ‘Illiquidity and Stock Returns: Cross-section and Time-series Effects.’ Journal of Financial Markets 5: 31–56] illiquidity measure; and reduces stock volatility. Overall, our results suggest that short selling helps to stabilize asset prices, provides additional liquidity and improves market quality, even in an emerging economy with a less developed stock market than that in the US and Europe.     

Short-selling activities in the time of COVID-19

This study examines the daily short-selling activities in the U.S. market during the early 2020 outbreak of the COVID-19 global pandemic. Our findings indicate firms that are more sensitive to the shock (i.e., with high foreign exposure, low financial or operating flexibility, or high supply-chain exposure) were shorted more heavily. Moreover, short-selling activities during the COVID-19 pandemic, blamed for triggering stock market crashes, were primarily concentrated around overpriced stocks. This finding supports the argument that short selling plays a prominent role in improving price discoveries. Our research provides timely empirical evidence supporting the U.S. Securities and Exchange Commission's (SEC) non-intervention approach in banning short selling in the U.S. market.