NBER short selling study finds Asensio to be the Pioneer of recently defined field.   See www.asensio.com  There are plenty of research reports and case studies on short selling hyped frauds. A worthwhile education.

March 5th, 2014.  In January 2014 the National Bureau of Economic Research [“NBER”] published a behavioral finance article titled the first titled “How Constraining Are Limits to Arbitrage? Evidence from a Recent Financial Innovation.”  The study indentifies Manuel P. Asensio of Asensio & Company as the “pioneer” of short selling “arbitrage” and found that Asensio & Company’s short targets experienced the largest price correction among this recent class of short sellers during the study’s timeframe.   The study defines this recent class of arbitrage short seller as “information producers as arbitrageurs rather than as short-sellers, to distinguish them from uninformed short-sellers in the market.”

The study describes a “recent financial innovation that allows limits to arbitrage to be sidestepped, and overvaluation thereby to be corrected” even in settings characterized by extreme costs of information discovery and severe short-sale constraints or limits.  Limits “interfere with arbitrage processes so that security prices can deviate from true values for extended periods of time” and include costs of discovering a mispriced security, the costs of the resources needed to exploit a mispricing and short-sale constraints and the risk that mispricing could get worse, forcing early liquidation of a position at a loss.  Limits mentioned in the study also include “sophisticated public relations campaigns against shorts” and targets that “put pressure on their shareholders to recall stock out on loan, to put a squeeze on short sellers.” Yet the study found that short selling arbitrage can succeed in correcting mispricing and generate cumulative abnormal profits “even in this uninviting setting.”

The study “arbitrageurs” expend considerable resources to identify overvalued companies and profitably correct overpricing.  It notes that short selling arbitrageurs reveal their information publicly as a way to sidestep the so-called limits and found evidence that “revealing the information voluntarily and thereby accelerating price discovery reduces the risk of the arbitrage strategy and sidesteps the arbs’ limited-resource constraint.”

The study found that “[f]or this strategy to work, critical that the information the arbs reveal to the market is credible – or else the longs will ignore it. We observe that the arbs in our sample argue their case by way of highly detailed reports which they post publicly and for free.  Compared to reports published by sell-side equity analysts at investment banks, which have a tendency to be bothoptimistic and biased.”

The study contributes to the “growing literature on the role of short sellers in producing and transmitting information in capital markets. There is little prior evidence on what short sellers know and how they acquire information. Our unique data allow us to observe the information discovery process at the level of individual information producers and to study how the information the arbs discover is then incorporated in security prices.”

The study found the short seller arbitrageur evidence ‘illustrates why financial markets need short sellers to function well. While some short sellers may indeed be speculators who do little more than destabilize share prices, as is often alleged, the short sellers in our sample are information producers who help correct mispricing and thereby help make markets more efficient. This is all the more remarkable given that many targets in our sample were held by highly sophisticated investors who apparently did not spot the overvaluation until it was too late.”

The study is available at http://www.nber.org/papers/w19834 

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