From Extinction to Resurrection: Unveiling the Role of Short-Selling Frictions in Cross-Sectional Momentum

Abstract

We investigate the impact of short-selling constraints on the cross-sectional momentum effect (CME), unveiling four key findings. First, the CME has nearly vanished after 2000, as short-selling capacity increased. Second, conditioning on short-selling information, the CME remains highly significant for the most constrained stocks. Third, the negative correlation between firm size and momentum, primarily arises from difficulties in short-selling small stocks, especially winners, challenging the "gradual information-diffusion" model. Fourth, we document the predictive role of aggregate sentiment, particularly for losers. These findings support Scheinkman and Xiong (2003)’s prediction of a link between short-selling constraints and asset pricing dynamics. 

Keywords: Empirical Asset Pricing, Momentum, Short-selling frictions

JEL Classification: G10, G11, G14