Short Selling Efficiency
56 Pages Posted: 15 Jun 2020 Last revised: 20 Jul 2021
Date Written: July 16, 2020
Short selling efficiency (SSE), measured each month by the slope coefficient of cross-sectionally regressing abnormal short interest on a mispricing score, significantly and negatively predicts stock market returns both in-sample and out-of-sample, suggesting that mispricing gets corrected after short sales are executed on the right stocks. We show conceptually and empirically that SSE has favorable predictive ability over aggregate short interest, as SSE reduces the effect of noises in short interest and better captures the amount of aggregate short selling capital devoted to overpricing. The predictive power is stronger during the periods of recession, high volatility, and low public information. In addition, low SSE precedes the months when the CAPM performs well and signals efficient market. Overall, our evidence highlights the importance of the disposition of short sales in stock markets.
Keywords: Short Selling Efficiency, Return Predictability, Mispricing, Market Efficiency
JEL Classification: G11, G23
Suggested Citation: Suggested Citation