Fails to Deliver: The Price Impact of Naked Short Sales

Abstract

The effect of naked short selling on asset prices and trading dynamics is a prominent topic of debate among market participants, regulators, and the popular press. This paper evaluates the validity of the claim that naked shorting leads to negative excess returns by creating additional selling pressure. While data on naked short sales is not publicly available, Securities Exchange Commission data on failures to deliver is a strong proxy. Fail to deliver data for 2004 covers a period during which the prevalence of naked short selling was not public knowledge since neither the fail to deliver data nor the Regulation SHO List were publicly available. In excluding information and regulation effects, the analysis presented in this paper isolates potential microstructure price effects. Using a methodology that constructs daily portfolios according to the quantity of naked short selling, I find no evidence that stocks subject to naked short selling experience negative excess returns. Rather, I find evidence that these stocks outperform on the day the trades occur. Naked short sellers appear to target stocks that outperform during the trading day and cover existing fails on days when the stocks underperform. This outperformance is not evident for stocks subject to the greatest amount of naked short selling, suggesting that positive excess returns may be offset by the additional selling pressure.

Keywords: Short Selling, Fails to Deliver, Regulation SHO, SEC

JEL Classification: G10, G18