Days to Cover and Stock Returns
63 Pages Posted: 26 Feb 2015 Last revised: 11 Nov 2016
Date Written: August 2016
A crowded trade emerges when speculators' positions are large relative to the asset's liquidity, making exit difficult. We study this problem of recent regulatory concern by focusing on short-selling. We show that days to cover (DTC), the ratio of short interest to trading volume, measures the costliness of exiting crowded trades. Crowding is an important concern as short-sellers avoid illiquid stocks, which we establish using an instrumental-variables strategy involving staggered stock market decimalization reforms. Arbitrageurs require a premium to enter into such trades as a strategy shorting high DTC stocks and buying low DTC stocks generates a 1.2% monthly return. A smaller days-to-cover effect also exists on the long positions of levered hedge funds.
Keywords: Days to Cover, Crowded Trades, Stock Returns
JEL Classification: G12, G14
Suggested Citation: Suggested Citation