Role of Short Sellers in Price Formation - the Weekend Effect

Abstract

In this paper, we argue that short sellers affect prices in a significant and systematic manner. In particular, we contend that speculative short sales contribute to the weekend effect: the inability to trade over the weekend is likely to cause these short sellers to close many of their speculative positions on Fridays and reestablish new short positions on Mondays causing stock prices to rise on Fridays and fall on Mondays.

We find evidence in support of this hypothesis: the weekend effect is significantly larger for high short-interest stocks than for low short-interest stocks. Further, we find that the likely substitution of speculative short sales by put options results in the weekend effect to diminish for stocks with actively traded options, but to continue for other stocks. An analysis of several special types of stocks, viz. IPOs, zero short-interest stocks, and highly volatile stocks, reveals support for the hypothesis.

JEL Classification: G14