Covering Trades Uncovered

Abstract

We investigate whether short sellers are informed when they exit their positions, using publicly disclosed short positions in European stock markets. We find that short covering trades are associated with positive price impact, and future abnormal returns depend on the profitability of the short sellers when they decide to cover their trade. In particular, profits (losses) positively (negatively) predict future abnormal returns. Our results suggest that short sellers are generally informed when covering their shorts, but they are also sensitive to limits to arbitrage leading them to sometimes close their positions prematurely.

Keywords: short selling, covering trades, short squeeze, limits to arbitrage JEL Classification: G14