Price Discovery in the Corporate Bond Market: The Informational Role of Short Interest

61 Pages Posted: 6 Nov 2011 Last revised: 20 Mar 2012

See all articles by Paul A. Griffin

Paul A. Griffin

University of California, Davis - Graduate School of Management; University of California, Davis

Hyun A. Hong

University of California, Riverside (UCR) - A. Gary Anderson Graduate School of Management

Date Written: March 13, 2012

Abstract

This paper identifies a precursory role of short sellers in conveying adverse information to the corporate bond market. We study this in two ways, by examining subsequent calendar month excess (risk-adjusted) bond returns for portfolios formed on the basis of high short interest in a prior month, and by analyzing abnormal short interest and daily bond returns around earnings announcements. A zero-investment hedge portfolio of bonds based on the most and least extreme high short interest positions generates a statistically significant annualized excess return of 3.84 percent. Our findings are consistent with the view that short interest plays an informational role in setting bond prices. In the context of earnings announcements, this occurs because short traders benefit from useful information prior to a news announcement, possibly from leakage or private access, and perform a more rigorous analysis of the announcement itself, where such analysis is reflected in prices with delay. Taken together, these findings support the theoretical prediction of Diamond and Verrecchia (1987) that higher-levels of short interest convey unpublicized adverse information, thereby contributing to price discovery in securities markets.

Keywords: Short interest, corporate bonds, excess bond returns, Regulation SHO, price discovery, earnings announcements

JEL Classification: G12, G14, G24, M41

Suggested Citation

Griffin, Paul A. and Hong, Hyun A., Price Discovery in the Corporate Bond Market: The Informational Role of Short Interest (March 13, 2012). 2012 Financial Markets & Corporate Governance Conference. Available at SSRN: https://ssrn.com/abstract=1955345 or http://dx.doi.org/10.2139/ssrn.1955345

Paul A. Griffin (Contact Author)

University of California, Davis - Graduate School of Management ( email )

3102 Gallahger Hall
Davis, CA 95616
United States
(530) 752-7372 (Phone)
(425) 799-4143 (Fax)

HOME PAGE: http://www.gsm.ucdavis.edu/griffin/

University of California, Davis ( email )

3102 Gallahger Hall
Davis, CA 95616
United States
(530) 752-7372 (Phone)
(425) 799-4143 (Fax)

HOME PAGE: http://www.gsm.ucdavis.edu/griffin/

Hyun A. Hong

University of California, Riverside (UCR) - A. Gary Anderson Graduate School of Management ( email )

Riverside, CA 92521
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
246
Abstract Views
1,649
rank
127,386
PlumX Metrics