When Do Short Sellers Exit Their Positions?
54 Pages Posted: 27 Aug 2018 Last revised: 18 Nov 2021
Date Written: November 17, 2021
We construct novel measures of gross and net short covering to examine when short sellers exit their positions. We find that idiosyncratic limits to arbitrage, such as adverse stock price movements, volatility, and equity lending fees are associated with significantly higher position closures and lower price efficiency. Moreover, these position closures predict future return movements in the wrong direction, suggesting short sellers may be induced to exit too early. In contrast, we find little evidence that aggregate limits to arbitrage including VIX, funding liquidity, and market volatility affect gross or net short covering. The results show that firm-level limits to arbitrage are important determinants of trading behavior.
Keywords: limits to arbitrage, market efficiency, short sales, short covering
JEL Classification: G12, G14
Suggested Citation: Suggested Citation