Informed Trading Before Analyst Downgrades: Evidence from Short Sellers

61 Pages Posted: 22 Mar 2008 Last revised: 26 Apr 2009

See all articles by Stephen E. Christophe

Stephen E. Christophe

George Mason University - Department of Finance

Michael G. Ferri

George Mason University

Jim Hsieh

George Mason University

Date Written: October 17, 2008

Abstract

This paper studies short-selling prior to the release of analyst downgrades in a sample of 670 downgrades of NASDAQ stocks between 2000 and 2001. We document abnormal levels of short-selling in the three days before downgrades are publicly announced. Further, we show that this pre-announcement abnormal short-selling is significantly related to the subsequent share price reaction to the downgrade, and especially so for downgrades that prompt the most substantial price declines. Our findings are robust to various controls that might also affect short-selling such as pre-announcement momentum, three-day pre-announcement returns, and the announcement-day share price. In addition, the results are independent of scheduled earnings announcements, analyst herding, and non-routine events near downgrades. Further evidence suggests that tipping is more consistent with the data than the prediction explanation which posits that short sellers successfully predict downgrades on the basis of public information about firms’ financial health. Finally, we present evidence that downgraded stocks with high abnormal short-selling perform poorly over the subsequent six months by comparison with those with low abnormal short-selling. Overall, our results support the hypothesis that short sellers are informed traders and exploit profitable opportunities provided by downgrade announcements.

Keywords: Short sale, Analyst downgrades, Informed trading

JEL Classification: G11, G14, G24

Suggested Citation

Christophe, Stephen and Ferri, Michael G. and Hsieh, Jim, Informed Trading Before Analyst Downgrades: Evidence from Short Sellers (October 17, 2008). AFA 2009 San Francisco Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1108162 or http://dx.doi.org/10.2139/ssrn.1108162

Stephen Christophe (Contact Author)

George Mason University - Department of Finance ( email )

Fairfax, VA 22030
United States
703-993-1767 (Phone)
703-993-1870 (Fax)

Michael G. Ferri

George Mason University ( email )

School of Management
4400 University Drive
Fairfax, VA 22030
United States
703-993-1858 (Phone)

Jim Hsieh

George Mason University ( email )

4400 University Dr, MSN 5F5
George Mason University
Fairfax, VA 22030
United States

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