Short Selling and Cross-Section of Corporate Bond Returns

Abstract

This paper examines the relationship between short selling in the equity market and corporate bond returns. We show that both shorting activity and size of short trades are inversely correlated with contemporaneous bond returns. In addition, firms with heavily shorted shares or large short trade size experience significantly negative future bond returns. Further tests indicate that the relation between short trade size and subsequent bond returns is consistent with stealth trading of short sellers. The impact of both shorting activity and short trade size on bond returns is robust to various controls for risk, liquidity, and other pricing factors. In examining the sources of information in short selling, we find that firms associated with heavy short selling or large short trade size are likely to subsequently experience negative earnings surprises, higher credit risk, and reduced dividends. The overall results support the proposition that short trades in the equity market exert important valuation consequences in the corporate bond market.

Keywords: : short selling; short trade size; corporate bonds; stealth trading

JEL Classification: G11, G12, G14