Short-Sellers and Mutual Funds: Why Does Short-Sale Volume Predict Stock Returns?

54 Pages Posted: 17 Sep 2014 Last revised: 2 Oct 2016

See all articles by Salman Arif

Salman Arif

Indiana University - Kelley School of Business - Department of Accounting

Azi Ben-Rephael

Rutgers University, Newark, School of Business-Newark, Department of Finance & Economics

Charles M.C. Lee

Stanford University - Graduate School of Business

Date Written: September 30, 2016

Abstract

The ability of short-sale volume (SSV) to predict returns is closely related to price pressure from mutual funds (MFs). Daily directional trading by MFs is highly-persistent and price-destabilizing, leading to return reversals lasting months. At the same time, SSV reacts strongly in the opposite direction – when MFs buy (sell), SSV increases (decreases). Daily SSV is responsive to both the expected component of MF trades (based on prior days’ trading), and the unexpected component (based on same-day trading). Furthermore, SSV-strategies only predict returns when MFs are trading in the opposite direction. We conclude some short-sellers are strategic liquidity providers who detect and respond to price-destabilizing MF trades.

Keywords: Price discovery, mutual funds, short-sellers, price pressure, liquidity provision, market efficiency

JEL Classification: D40, G10, G12, G14, G20, G23

Suggested Citation

Arif, Salman and Ben-Rephael, Azi and Lee, Charles M.C., Short-Sellers and Mutual Funds: Why Does Short-Sale Volume Predict Stock Returns? (September 30, 2016). Rock Center for Corporate Governance at Stanford University Working Paper No. 195; Finance Down Under 2016 Building on the Best from the Cellars of Finance; Stanford University Graduate School of Business Research Paper No. 14-35. Available at SSRN: https://ssrn.com/abstract=2496990 or http://dx.doi.org/10.2139/ssrn.2496990

Salman Arif

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States

Azi Ben-Rephael

Rutgers University, Newark, School of Business-Newark, Department of Finance & Economics ( email )

111 Washington Avenue
Newark, NJ 07102
United States

HOME PAGE: http://sites.google.com/site/abenreph

Charles M.C. Lee (Contact Author)

Stanford University - Graduate School of Business ( email )

Stanford Graduate School of Business
655 Knight Way
Stanford, CA 94305-5015
United States
650-721-1295 (Phone)

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