The Costs and Benefits of Long-Short Investing: A Perspective on the Market Efficiency Literature

Journal of Accounting Literature, Forthcoming

45 Pages Posted: 22 Mar 2014 Last revised: 1 Oct 2016

See all articles by William H. Beaver

William H. Beaver

Stanford University

Maureen F. McNichols

Stanford University

Richard A. Price

University of Oklahoma

Date Written: May 1, 2016

Abstract

We highlight key assumptions implicit in the models used by academics conducting research on market efficiency. Most notably, many academics assume that investors can borrow unlimited amounts and construct long-short portfolios at zero cost. We relax these assumptions and examine the attractiveness of long-short strategies as stand-alone investments and as a part of a diversified portfolio. Our analysis illustrates that the key benefit of long-short investing is adding diversification to a portfolio beyond what the market provides. We show that as stand-alone investments, nontrivial risk remains in the “hedge” strategies and that the returns generally do not beat the market in a head-to-head contest. Our findings raise questions about the degree of inefficiency in anomaly studies because plausible measures of costs generally offset strategy returns. The ability to achieve greater diversification may be, but is not necessarily, due to market inefficiency. We also highlight the key role of the generally ignored but critically important short interest rebate and show that absent this rebate, the long-short strategies we examine generally yield insignificant returns.

Keywords: Accounting-Based Anomalies; Long-Short Strategies; Short Selling; Market Efficiency; Sharpe Ratio; Short Interest Rebates

JEL Classification: G11; G12; G14; M41

Suggested Citation

Beaver, William H. and McNichols, Maureen F. and Price, Richard A., The Costs and Benefits of Long-Short Investing: A Perspective on the Market Efficiency Literature (May 1, 2016). Journal of Accounting Literature, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2412547 or http://dx.doi.org/10.2139/ssrn.2412547

William H. Beaver

Stanford University ( email )

655 Knight Way
Stanford, CA 94305-5015
United States
650-723-4409 (Phone)
650-725-6152 (Fax)

Maureen F. McNichols

Stanford University ( email )

655 Knight Way
Stanford, CA 94305-5015
United States
650-723-0833 (Phone)
650-725-7979 (Fax)

Richard A. Price (Contact Author)

University of Oklahoma ( email )

307 W Brooks
Norman, OK 73019
United States
405-325-5759 (Phone)

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