Forecasting in Periods of Heightened Uncertainty: The Importance of Aggregate Short Interest

Abstract

Our study demonstrates that aggregate short interest is a stronger predictor of the equity risk premium during periods of heightened financial uncertainty. Our findings strengthen the hypothesis that, during such times, disagreement among investors and downward pressure on prices allow well-informed short sellers to generate more accurate forecasts. Our results offer valuable insights into enhancing equity return forecasting, an ongoing challenge that has sparked considerable debate in recent literature.

Keywords: short interest, equity risk premium, financial uncertainty, investor disagreement, well-informed short sellers, stock market predictability