Should Investors Follow the Prophets or the Bears? Evidence on the Use of Public Information by Analysts and Short Sellers

46 Pages Posted: 17 Sep 2008 Last revised: 27 Aug 2010

See all articles by Michael S. Drake

Michael S. Drake

Brigham Young University - Marriott School

Lynn L. Rees

Utah State University - Huntsman School of Business

Edward P. Swanson

Texas A&M University - Mays Business School; Mays Business School, Texas A&M University

Date Written: August 25, 2010

Abstract

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.

Keywords: analysts' recommendations, short sellers, trading strategy, fundamental analysis

JEL Classification: G14, G29, M41, M49

Suggested Citation

Drake, Michael S. and Rees, Lynn L. and Swanson, Edward P., Should Investors Follow the Prophets or the Bears? Evidence on the Use of Public Information by Analysts and Short Sellers (August 25, 2010). The Accounting Review, Vol. 86, No. 1, 2011. Available at SSRN: https://ssrn.com/abstract=1269427 or http://dx.doi.org/10.2139/ssrn.1269427

Michael S. Drake

Brigham Young University - Marriott School ( email )

United States

Lynn L. Rees (Contact Author)

Utah State University - Huntsman School of Business ( email )

3500 Old Main Hill
Logan, UT 84322-3500
United States
435-797-2272 (Phone)

Edward P. Swanson

Texas A&M University - Mays Business School ( email )

430 Wehner
College Station, TX 77843-4353
United States
979-845-8970 (Phone)
979-845-0028 (Fax)

Mays Business School, Texas A&M University ( email )

Wehner, MS 4353
College Station, TX 77843-4353
United States
979-845-5014 (Phone)
979-845-0028 (Fax)

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