Short Interest in Bonds and Aggregate Stock Returns

Abstract

Short interest in corporate bonds negatively predicts aggregate stock returns. In- and out-of-sample tests suggest that this predictability is stronger and more long-lasting compared to short interest in stocks, corporate bond variables, and other well-known predictors of stock market returns. Short interest in bonds captures informed trading as evidenced by its ability to predict aggregate bond return characteristics, credit spreads, and changes in firm fundamentals, including default probabilities and earnings surprises. Predictability is the strongest in periods when stock and bond markets have more frictions, which impair market integration and delay information diffusion between markets.

Keywords: short interest, corporate bonds, aggregate stock returns, predictive regressions, informed traders

JEL Classification: G12, G14, G17