Do Arbitrageurs Amplify Economic Shocks?
Harrison G. Hong
Columbia University, Graduate School of Arts and Sciences, Department of Economics; National Bureau of Economic Research (NBER)
Jeffrey D. Kubik
Syracuse University - Department of Economics
Princeton University - Bendheim Center for Finance; Princeton University - Department of Economics
June 1, 2011
We test the hypothesis that arbitrageurs amplify economic shocks in equity markets. The ability of speculators to hold short positions depends on asset values: shorts are often reduced following good news about a stock. Therefore, the prices of highly shorted stocks are excessively sensitive to shocks compared to stocks with little short interest. We confirm this hypothesis using several empirical strategies including two quasi-experiments. In particular, we establish that the price of highly shorted stocks overshoots after good earnings news due to short covering compared to other stocks.
Number of Pages in PDF File: 52
Date posted: March 2, 2007 ; Last revised: June 4, 2011