Biased Shorts: Stock Market Implications of Short Sellers’ Disposition Effect

32 Pages Posted: 2 Nov 2013

See all articles by Bastian von Beschwitz

Bastian von Beschwitz

Board of Governors of the Federal Reserve System

Massimo Massa

INSEAD - Finance

Date Written: November 1, 2013

Abstract

We investigate whether short sellers are subject to the disposition effect using a novel dataset that allows to identify the weekly closing of short positions. Consistent with the disposition effect, the closing of short sale positions is strongly related to a proxy of Shortsale Capital Gains Overhang (SCGO). Furthermore, while short sellers in general exhibit skill in closing their positions – i.e. closing is followed by positive stock returns – the closing explained by SCGO is followed by negative returns. This suggests that the trades are irrational and caused by the disposition effect. Next, we study the implications of short sellers’ disposition effect on stock prices. We provide evidence that SCGO is negatively related to future stock returns. This effect exists after controlling for the standard effect of capital gains overhang of other market participants. A trading strategy based on SCGO achieves yearly three-factor alphas of up to 26%. Overall, our results suggest that short sellers, instead of arbitraging away the mispricing caused by the disposition effect of the other market participants, add to this mispricing due to their own behavioral biases.

Keywords: Short selling, Disposition effect, Behavioral Finance

JEL Classification: G10, G12, G14

Suggested Citation

von Beschwitz, Bastian and Massa, Massimo, Biased Shorts: Stock Market Implications of Short Sellers’ Disposition Effect (November 1, 2013). Available at SSRN: https://ssrn.com/abstract=2348583 or http://dx.doi.org/10.2139/ssrn.2348583

Bastian Von Beschwitz (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Massimo Massa

INSEAD - Finance ( email )

Boulevard de Constance
F-77305 Fontainebleau Cedex
France
+33 1 6072 4481 (Phone)
+33 1 6072 4045 (Fax)

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