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The Cost of Shorting, Asymmetric Performance Reaction and the Price Response to Economic Shocks

36 Pages Posted: 11 Jan 2015  

Jose Renato Haas Ornelas

Banco Central do Brasil

Pablo Jose Campos de Carvalho

Banco Central do Brasil

Date Written: January 9, 2015

Abstract

We propose and test a model of asymmetric performance-based arbitrage. While short arbitrageurs are forced to reduce their positions after a negative return, positive returns have no immediate effect on their managed funds. This price reaction is bounded by short-selling costs, because while short selling activity may generate overshooting, transaction costs may keep it limited. This paper empirically tests model predictions using Brazilian short-selling data. We show that there is an overshooting after good news for highly shorted stocks, but it is offset by trading and shorting costs indicating that short selling bans may be unnecessary to smooth market conditions. We also find support to the behavioral feature of our model that suggests that arbitrageurs behave asymmetrically to the types of news.

Keywords: performance-based arbitrage, short-selling, Short covering, Leverage

JEL Classification: G11, G12, G14

Suggested Citation

Ornelas, Jose Renato Haas and de Carvalho, Pablo Jose Campos, The Cost of Shorting, Asymmetric Performance Reaction and the Price Response to Economic Shocks (January 9, 2015). Available at SSRN: https://ssrn.com/abstract=2547666 or http://dx.doi.org/10.2139/ssrn.2547666

Jose Renato Haas Ornelas (Contact Author)

Banco Central do Brasil ( email )

P.O. Box 08670
SBS Quadra 3 Bloco B - Edificio-Sede
Brasilia, Distrito Federal 70074-900
Brazil

HOME PAGE: http://www.bcb.gov.br

Pablo Jose Campos De Carvalho

Banco Central do Brasil ( email )

P.O. Box 08670
SBS Quadra 3 Bloco B - Edificio-Sede
Brasilia, Distr. Federal 70074-900
Brazil

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