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High Short Interest Effect and Aggregate Volatility Risk

52 Pages Posted: 8 Sep 2011 Last revised: 10 Jan 2015

Alexander Barinov

University of California Riverside

J. (Julie) Wu

University of Nebraska at Lincoln

Date Written: September 17, 2014

Abstract

We propose a risk-based firm-type explanation on why stocks of firms with high relative short interest (RSI) have lower future returns. We argue that these firms have negative alphas because they are a hedge against expected aggregate volatility risk. Consistent with this argument, we show that these firms have high firm-specific uncertainty and option-like equity, and the aggregate volatility risk factor can largely explain the high RSI effect. The key mechanism is that high RSI firms have abundant growth options and, all else equal, growth options become less sensitive to the underlying asset value and more valuable as idiosyncratic volatility goes up. Idiosyncratic volatility usually increases with aggregate volatility (i.e., in recessions).

Keywords: aggregate volatility risk, short interest, real options, mispricing

JEL Classification: G12, G13, G32, E44, D80

Suggested Citation

Barinov, Alexander and Wu, J. (Julie), High Short Interest Effect and Aggregate Volatility Risk (September 17, 2014). Journal of Financial Markets, 21: 98-122, 2014. Available at SSRN: https://ssrn.com/abstract=1924391 or http://dx.doi.org/10.2139/ssrn.1924391

Alexander Barinov (Contact Author)

University of California Riverside ( email )

900 University Ave.
Anderson Hall
Riverside, CA 92521
United States
585-698-7726 (Phone)

HOME PAGE: http://faculty.ucr.edu/~abarinov/

J. (Julie) Wu

University of Nebraska at Lincoln ( email )

Lincoln, NE 68588
United States

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