Biased Shorts: Short Sellers’ Disposition Effect and Limits to Arbitrage
54 Pages Posted: 4 Nov 2015 Last revised: 7 Jul 2021
Date Written: November, 2015
Abstract
We investigate whether short sellers are subject to the disposition effect using a novel dataset that allows to identify the closing of short positions. Consistent with the disposition effect, short sellers are more likely to close a position the higher their capital gains. Furthermore, stocks with high short sale capital gains experience negative returns, suggesting that their disposition effect has an effect on stock prices. A trading strategy based on this finding achieves significant three-factor alphas. Overall, short sellers? behavioral biases limit their ability to arbitrage away the mispricing caused by the disposition effect of other market participants.
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