Short Selling: Some Notes and Literature

Short selling: It's a special thing.

These papers cover a variety of topics:

  1. Whether short sellers are better informed
  2. The market for lending securities
  3. Theories of how short selling affects asset prices
  4. Empirical studies of how impediments to short selling affect asset prices and market quality

There is a theory (Miller 1977) that says impediments to short selling (for any reason) will lead to overvalued assets. The Miller paper is a good paper to read for anyone in interested in asset prices. There is a strand of literature that tries to find evidence of this theory of overpricing. An overly simple test is to look for stocks that are difficult to short and see if these are overpriced. But figuring out what impediment to short selling really are and when they are binding is not so simple. On the other hand, empirical evidence or not it provides a nice framework to think about investing. A common and good (I think) rule of thumb is to always be careful when investing in popular assets. Often this is described as a “crowded trade”. If the overpricing theory is correct then this is a particularly important heuristic for asset classes that are not shortable.

Here is a related short sellers conundrum: If enough stock is sold short, it becomes hard to borrow. This could lead to overpricing above and beyond whatever misplacing enticed investors to short in the first place. (One might also ask why the stock was overpriced before it was hard to borrow.) If an investor can short this overpriced stock, then there is risk of being part of a crowded short. Though it could be seen as a crowded long as well. Either way these situations are weird, fascinating and probably informative about more than the stock itself.

For the most part short sales are seen as informative about an individual stock. A popular idea is that short sales in a stock predict a decline in prices (though some used to say the opposite). Among those who believe this, it is still an unsettled question as to whether this is because short sellers have valuable private information or if they are better at analyzing publicly available information. (Some economists make no distinction between these types of information, one is just more informed.) If the short sellers are indeed better informed, then we should want to know if we can improve returns by avoiding (or shorting) stocks that others are shorting. Or, as one paper suggests, overweighting stocks that are less shorted than their peers.

It is not always easy to sell short. In some cases it is impossible other times it is just expensive or risky. This creates an interesting link between option markets and short selling since options can be a substitute for short stock. A related fact makes this even more interesting: option market makers have had a special advantages in borrowing shares thus either increasing the effective supply of shares or reducing costs while disintermediating prime brokers. Since it is a popular (though maybe untrue) belief that both options traders and short sellers are informed, there are a few investigations into whether options trading volume is informative.

A key element of all shorting activity is the market for lending shares. This is not a new market, but until recently data was hard to find and there is a lot yet to be written about it. In 2008 there was a ban on short selling in many jurisdictions and this provided a natural experiment to examine how supply shifts in the lending market impact other markets.

Short Sales Are Almost Instantaneously Bad News: Evidence from the Australian Stock Exchange

Family-Controlled Firms and Informed Trading: Evidence from Short Sales (SSRN Version)

The Cost of Short-Selling Liquid Securities (CiteSeerX Version)

Regulatory Uncertainty and Market Liquidity: The 2008 Short Sale Ban's Impact on Equity Option Markets (SSRN Version)

Short-Selling Bans Around the World: Evidence from the 2007–09 Crisis (CiteSeerX Version)

Which Shorts Are Informed? (CiteSeerX Version)

Efficiency and the Bear: Short Sales and Markets Around the World (CiteSeerX Version)

Short-Sales Constraints and Price Discovery: Evidence from the Hong Kong Market (SSRN Version)

Supply and Demand Shifts in the Shorting Market (CiteSeerX Version)

It's SHO Time! Short-Sale Price Tests and Market Quality (SSRN Version)

Who Blows the Whistle on Corporate Fraud? (CiteSeerX Version)

Short Sellers and Financial Misconduct (AFA Version)

A Multiple Lender Approach to Understanding Supply and Search in the Equity Lending Market (FRB Version)

Can Short Restrictions Actually Increase Informed Short Selling? (SSRN Version)

The Dog That Did Not Bark: Insider Trading and Crashes CiteSeerX Version)

Downward-Sloping Demand Curves, the Supply of Shares, and the Collapse of Internet Stock Prices (CiteSeerX Version)

Short sales, institutional investors and the cross-section of stock returns (CiteSeerX Version)

Shackling Short Sellers: The 2008 Shorting Ban (SSRN Version)

Connecting two markets: An equilibrium framework for shorts, longs, and stock loans (SSRN Version)

The Effects of Dividend Taxation on Short Selling (SSRN Version)

Short Arbitrage, Return Asymmetry, and the Accrual Anomaly (SSRN Version)

Do Equity Short Sellers Anticipate Bond Rating Downgrades?

Informed trading before analyst downgrades: Evidence from short sellers (SSRN Version)

Finite Bubbles with Short Sale Constraints and Asymmetric Information (Author Page Version)

An Investigation of the Informational Role of Short Interest in the Nasdaq Market (SSRN Version)

Short-Sale Constraints, Differences of Opinion, and Overvaluation (SSRN Version)

Short-sellers, fundamental analysis, and stock returns (SSRN Version)

The value of shorting

Worldwide reach of short selling regulations (CiteSeerX Version)

The role of shorting, firm size, and time on market anomalies (SSRN Version)

The good news in short interest (SSRN Version)

The Effects of Stock Lending on Security Prices: An Experiment (SSRN Version)

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

Short-sale inflow and stock returns: Evidence from Japan

Short-Selling Prior to Earnings Announcements (Researchgate Version)

Doing battle with short sellers: The conflicted role of blockholders in bear raids (SSRN Version)

Do option markets undo restrictions on short sales? Evidence from the 2008 short-sale ban (SSRN Version)

Special Repo Rates (Author Page)

Short interest, institutional ownership, and stock returns (SSRN Version)

The skinny on the 2008 naked short-sale restrictions (SSRN Version)

The market for borrowing stock (SSRN Version)

Securities lending, shorting, and pricing (SSRN Version)

How are shorts informed?

Differences of Opinion, Short‐Sales Constraints, and Market Crashes (SSRN Version)

Risk, Uncertainty and Divergence of Opinion

Shorting Restrictions: Revisiting the 1930s (Columbia GSB Page)

Short Selling and the Price Discovery Process (SSRN Version)

Constraints on short-selling and asset price adjustment to private information (Author Page)

Short selling in initial public offerings (SSRN Version)

Strategic delivery failures in U.S. equity markets

Stocks are special too: an analysis of the equity lending market (CiteSeerX Version)

Failure Is an Option: Impediments to Short Selling and Options Prices (SSRN Version)

The options market maker exception to SEC Regulation SHO (SSRN Version)

Bears and Numbers: Investigating How Short Sellers Exploit and Affect Earnings-Based Pricing Anomalies (SSRN Version)

The short of it: Investor sentiment and anomalies (SSRN Version)

Short-Sale Strategies and Return Predictability (SSRN Version)

Short-sale constraints and stock returns (SSRN Version)

Price Efficiency and Short Selling (SSRN Version)

Do hedge funds trade on private information? Evidence from syndicated lending and short-selling (SSRN Version)

An Empirical Investigation of Short-Selling Activity Prior to Seasoned Equity Offerings

Affiliated Agents, Boards of Directors, and Mutual Fund Securities Lending Returns (SSRN Version)

What Do Short Sellers Know? (SSRN Version)

Naked Short Sales and Fails to Deliver: An Overview of Clearing and Settlement Procedures for Stock Trades in the US (SSRN Version)