TWO ESSAYS ON SHORT SELLING

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2013-05

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Abstract

This dissertation consists of two essays on short sellers' trading behavior. The first essay examines if short sellers exploit temporary mispricing in the equity market. Using a mispricing indicator that measures deviations from a stock's fundamental value, we find higher levels of short selling for temporarily overvalued stocks. The result is robust to controlling for short sale constraints and illiquidity, and it is more pronounced when short sale constraints do not bind and stocks are liquid. The result also remains intact after controlling for short sellers' reaction to fundamental information. We find that short sellers contribute to market quality by correcting overpricing quickly over time, but do not destabilize the stock market. The second essay documents trading activity of short sellers through the examination of intraday patterns in short sales. We find a U-shaped intraday pattern in short sales across the trading day. This pattern is robust to controlling for short trade size, market capitalization, and institutional ownership. We also find a positive association between short selling and past returns across the trading day, and this result is more pronounced in the first and last half hours of the day. A trading strategy based on intraday short sales generates the highest returns at the open of the trading day. Overall, the results suggest that high levels of short sales at the market open are attributed to strategic trading by informed short sellers. High levels of effective spreads and volatility at the open also support our findings.

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Keywords

Short selling, Mispricing, Fundamentals, Short sale constraints, Market quality, Intraday short sales, Informed trading, Contrarian

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