Profitability of Hedge Fund Short Sales: Evidence from Opening and Closing Transactions

Abstract

We examine the profitability of hedge fund equity short sales. We identify opening and closing trades by combining data on funds’ transactions and holdings. Short sales covered within five trading days are highly profitable, but those kept open longer are not. Some of the profitability is due to trading on information and some stems from liquidity provision in both opening and covering trades. The finding that longer-term short trades are not profitable indicates that it is difficult to achieve the returns that results in the short-selling literature suggest should be readily attainable. Short selling profitability is persistent, consistent with skill.

Keywords: Hedge funds, short sale profitability, short sales, institutional investors

JEL Classification: G12, G14, G23