Short Sellers: Is The Advantage In Information, Or Timing?

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There is overwhelming evidence that short sellers are informed traders. In particular, a number of empirical papers find that short selling predicts future returns (Asquith and Meulbroek (1995), Senchack and Starks (1993), and Boehmer, Jones, and Zhang (2008)). Return predictability, however, tells us little about how short sellers obtain an informational advantage over other traders. In this paper we address this question by combining a database of public news events with a database of all short sale trades, a unique combination that allows us to comprehensively examine the relation between short selling and the release of public information.

One aspect of the relation between short sales and news that has received a lot of attention in the literature is timing. Short sellers have been shown to trade before public information is released. For example, Karpoff and Lou (2009) show that short selling increases before the initial public revelation of firms’ financial misrepresentation. Similarly, Christophe, Ferri, and Angel (2004) find evidence of informed short selling in the five days before earnings announcements. The financial crisis has also been linked to the timing of short sellers’ trades, with the Securities and Exchange Commission suggesting that short sellers spread “false rumors” in an effort to manipulate firms “uniquely vulnerable to panic.”

To examine whether short sellers’ informational advantage is due to timing, we begin by looking for evidence of abnormal short selling ahead of news events in the U.S. over the 2005 to 2007 period, a pattern that would be consistent with anticipation. We find no such pattern. In fact, we find that the ratio of short sales to total volume is nearly constant around news events. Further, when we do find differences between the timing of short sellers’ trades and the overall market, we observe that, relative to other types of trading, there is a significant increase in short selling after the news event. This result indicates that, on average, short sellers trade on publicly available information, that is, they do not uncover and trade on information before it becomes public.

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