Should Investors Follow the Prophets or the Bears? Evidence on the Use of Public Information by Analysts and Short Sellers
Michael S. Drake
Brigham Young University - Marriott School
Lynn L. Rees
Texas A&M University - Department of Accounting
Edward P. Swanson
Texas A&M University - Mays Business School
August 25, 2010
The Accounting Review, Vol. 86, No. 1, 2011
We investigate whether shorts and analysts differ in their use of fundamental and other information that is predictive of future returns. Remarkably, open short interest is significantly associated in the expected direction with all eleven variables examined. In contrast, analysts tend to positively recommend stocks with high growth, high accruals, and low book-to-market ratios -- despite these variables having a negative association with future returns. These results suggest that short sellers can serve as an alternative information intermediary for investors. We then investigate the profitability of using short interest in trading. We find abnormal returns (1.11 percent per month) from a zero-investment strategy that 1) shorts firms with highly favorable analyst recommendations (buy signal) but high short interest (sell signal), and 2) buys firms with highly unfavorable analyst recommendations (sell signal) but low short interest (buy signal). Short interest, therefore, captures predictive information that can be used by investors in trading against analysts’ recommendations to increase returns.
Number of Pages in PDF File: 46
Keywords: analysts' recommendations, short sellers, trading strategy, fundamental analysis
JEL Classification: G14, G29, M41, M49working papers series
Date posted: September 17, 2008 ; Last revised: August 27, 2010
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