Short-Selling and Credit Default Swap Spreads — Where Do Informed Traders Trade?

Abstract

During the global financial crisis, short‐selling and credit default swaps (CDS) gained notoriety as indicators of financial collapse. This paper extends the literature by examining the relationship between short‐selling and CDS spreads. Results indicate that lagged short‐selling metrics forecast changes in CDS spreads; short‐selling is found to have a positive relationship with CDS spreads. These results are robust to various controls including the supply of stock for short‐selling, changes in CDS spreads, cross‐sectional controls for fixed effects, sub‐group analysis by industry sector, and the use of contemporaneous explanatory variables. This suggests that informed traders prefer to short‐sell the underlying stocks.