A Long and a Short Leg Make For a Wobbly Equilibrium
72 Pages Posted: 25 Oct 2021
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A Long and a Short Leg Make For a Wobbly Equilibrium
A Long and a Short Leg Make for a Wobbly Equilibrium
Date Written: October 19, 2021
Abstract
We document the historically bad performance of shorting strategies in late 2020 and early 2021. Short sellers started retreating several weeks before the dramatic growth in the online discussion of January 2021 and across numerous stocks, the majority of which were not heavily discussed online and did not experience an unusual increase in retail buying volume. We provide a model to explain how fears among short sellers can become self-fulfilling and lead to “run-type” behavior. The model also provides a novel explanation why rational short sellers may choose to leave the market even as mispricing widens.
Keywords: Asset Pricing with Frictions, Short Selling, Runs, Limits to Arbitrage
JEL Classification: G11, G12, G14
Suggested Citation: Suggested Citation