Do Short Sellers Convey Information About Changes in Fundamentals or Risk?

Abstract

We examine whether unexpected levels of short interest are associated with subsequent downward revisions in fundamentals and/or subsequent upward revisions in risk. We use prediction errors from monthly models of short interest over 1992-2000 to proxy for unexpectedly high (and low) short interest positions, and we compare changes in fundamentals (as captured by analysts' earnings forecasts) and changes in risk factor loadings that occur subsequent to these unexpected positions. Relative to a sample of control firms with the lowest unexpected short interest, we find that analysts revise downward their earnings forecasts more severely for firms with high unexpected short interest; in addition, realized earnings for the high unexpected short interest firms are more likely to fall short of the consensus forecast. Tests examining shifts in three-factor risk loadings following high unexpected short interest show little evidence of significant risk changes. Overall, our evidence suggests that the information short sellers exploit mainly concerns the market's misperception of these firms' fundamentals.