Options, Short Sales, and Market Completeness

Figlewski, Stephen; Webb, Gwendolyn P.

doi:10.2307/2328923

Cited by 146 publications

(183 citation statements)

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“…Most previous studies have used monthly stock-specific short interest data (e.g., Figlewski and Webb (1993), Figlewski (1981), Dechow, Hutton, Meulbroek, and Sloan (2001), Desai et al (2002), Asquith, Pathak, and Ritter (2005), and Singal and Xu (2005)). There are three important problems with using monthly short interest data.…”

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confidence: 99%

Can Short-sellers Predict Returns? Daily Evidence

Diether¹,

Lee

Werner

2005

SSRN Journal

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We test whether short-sellers in Nasdaq-listed stocks are able to predict future returns based on new SEC-mandated data for the first six months of 2005. There is a tremendous amount of short-term trading strategies involving short-sales during the sample: Short-sales represent 27 percent of Nasdaq share volume while monthly short-interest is about 3.1 percent of shares outstanding (5.5 days to cover). Short-sellers are on average contrarian -they sell short following positive returns. Increasing short-sales predict future negative returns, and the predictive power comes primarily from small trades. A trading strategy based on daily short-selling activity generates significant returns, but incurs costs large enough to wipe out any profits. * All three authors are at the Fisher College of Business, The Ohio State University. We are grateful for comments from Leslie Boni, Rudi Fahlenbrach, Frank Hatheway, David Musto, René Stulz, and seminar participants at the Ohio State University, the NBER Market Microstructure Group, and the University of Georgia. We thank Nasdaq Economic Research for data. All errors are our own.Many market observers accuse short-sellers of destabilizing markets by selling stocks (they do not even own) when prices are already trending downward, exacerbating the negative momentum. Issuers and journalists often characterize short-sellers' activities as immoral, unethical and downright un-American. 1 Academics and traders instead argue that short-sellers stabilize security prices by selling stocks when prices exceed fundamental values, thus helping correct market overreaction. Short-term over-reaction could be caused by impediments to short-selling, as high costs of executing short-sales may result in stock prices reflecting the opinions of optimistic investors only (Miller (1977)). 2 Some researchers have even argued that costly short-selling was one of the culprits behind the stock market bubble of the late 1990s (e.g., Ofek and Richardson (2003)).In this study, we use the SEC mandated tick-by-tick short-sale data for 2,815 Nasdaq-listed stocks for the period January 3, 2005 to June 30, 2005 to test whether short-sellers are contrarian or momentum traders and whether they are able to predict future returns. We test these hypotheses by studying the link between short-selling activity and future returns and how short-sellers react to past returns on a daily level.The literature on short-selling is growing rapidly. Most previous studies have used monthly stock-specific short interest data (e.g., Figlewski and Webb (1993), Figlewski (1981), Dechow, Hutton, Meulbroek, and Sloan (2001), Desai et al (2002), Asquith, Pathak, and Ritter (2005), and Singal and Xu (2005)). There are three important problems with using monthly short interest data.First, the monthly reporting frequency does not permit researchers to study short-term trading strategies. Second, monthly short interest data does not distinguish between the short interest of dealers (who are exempt from short-sale restrictions) from th...

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confidence: 99%

Can Short-sellers Predict Returns? Daily Evidence

Diether¹,

Lee

Werner

2005

SSRN Journal

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“…Figlewski (1981) finds a significant negative relationship between risky asset returns and short interest, with the latter used as a proxy for the amount of negative information which would otherwise results in short sales were there no restrictions. Repeating the same tests on another period, Figlewski and Webb (1993) still show the relationship to be negative, albeit non-significant. The use of the recorded short interest as a proxy for the amount of adverse information excluded from the market price requires that observed short positions be proportional to short sales to be undertaken in the absence of restrictions.…”

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confidence: 82%

Heterogeneous Expectations, Short Sales Regulation, and the Risk‐Return Relationship

L’Her

Suret

1995

The Financial Review

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This paper examines, in a Canadian context, the effect of short sales regulation on the risk‐return relationship. It shows that, theoretically, the opportunity cost induced by short sales regulation is positively related to the dispersion of agents' beliefs and negatively related to the security's liquidity level. The model is tested over the sixty‐month period from January 1985 through December 1989. All the 13,079 observations are pooled into a time series cross‐sectional model. The results corroborate that a negative linear relationship links expected risky asset returns and the divergence of agents' beliefs. This negative relationship is consistent with the presence of opportunity costs resulting from short sales regulation when return beliefs are heterogeneous. However, the negative relationship between security returns and dispersion of beliefs is essentially confined to illiquid securities, that is, those monitored by a small number of analysts.

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“…The empirical studies showed that the increases in short interest or short volume lead to the declines in stock returns (Diether et al, 2009a;Dehow et al, 2001;Asquith and 3) A large body of literature examines the effect of shorting on the shorted stock, except one paper (Hwang et al, 2017). Meulbroek, 1996;Conrad, 1994;Figlewski and Webb, 1993;Senchack and Starks, 1993). Academics also have studied the effect of the short-selling constraints on the asset prices.…”

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Can Short-Selling Alleviate the Underpricing?

Wang¹,

Lee²

2017

Glob Bus Financ Rev

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A B S T R A C TThis paper investigates whether short-selling facilitates arbitrage activity and mitigates the positive post-earnings announcement drift (PEAD), the well-known underpricing anomaly. Using the quarterly earnings announcement of the Korean Stock Exchange KOSPI200 composite stocks, we find that the positive earnings stock in a difficult-to-short industry experiences the larger and more persistent underpricing after earnings announcement than those in an easy-to-short industry; and that the severe underpricing in a difficult-to-short industry is associated with the short-sale constraint, not with their illiquidity or information inefficiency. We also find that the inverse relationship between the positive PEAD and its industry's short-ability is stronger during the inactive ELW trade period, weaker during the active ELW trade period. Our findings suggest that short-selling help not only the overpriced stocks but also the underpriced stocks revert back to its fundamental value by facilitating arbitrage activities.

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Options, Short Sales, and Market Completeness

Cited by 146 publications

References 1 publication

Can Short-sellers Predict Returns? Daily Evidence

Can Short-sellers Predict Returns? Daily Evidence

Heterogeneous Expectations, Short Sales Regulation, and the Risk‐Return Relationship

Can Short-Selling Alleviate the Underpricing?

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