Biased Shorts: Short Sellers' Disposition Effect and Limits to Arbitrage

54 Pages Posted: 4 Nov 2015

See all articles by Bastian von Beschwitz

Bastian von Beschwitz

Board of Governors of the Federal Reserve System

Massimo Massa

INSEAD - Finance

Date Written: 2015-11-03

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.

Keywords: Short selling, Disposition effect, Behavioral finance

Suggested Citation

von Beschwitz, Bastian and Massa, Massimo, Biased Shorts: Short Sellers' Disposition Effect and Limits to Arbitrage (2015-11-03). FRB International Finance Discussion Paper No. 1147. Available at SSRN: https://ssrn.com/abstract=2686074 or http://dx.doi.org/10.17016/IFDP.2015.1147

Bastian Von Beschwitz (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Massimo Massa

INSEAD - Finance ( email )

Boulevard de Constance
F-77305 Fontainebleau Cedex
France
+33 1 6072 4481 (Phone)
+33 1 6072 4045 (Fax)

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