Throwing in the Towel: When Short Sellers Fail-to-Deliver Price Reversals
33 Pages Posted: 5 Mar 2011
Date Written: March 4, 2011
Abstract
This study examines shorting activity, returns, and failures-to-deliver at the daily level. We find evidence that failures occur after periods of positive returns, which is consistent with the idea that short sellers are contrarian traders (Diether et al., 2009). We also find that the direct relation between failures and past returns is increasing is past shorting activity. We present two possible explanations for this observation. First, the increased demand for shorting activity dries up the fixed supply of lendable shares thus resulting in the inability of short sellers to borrow and deliver shares. Second, when short sellers are unable to predict price reversals, failures will occur. Our tests support the latter explanation as the direct relation between failures and past returns that is increasing in past shorting activity is driven by stocks with the greatest equity loan supply. Further, we find that abnormally high failures do not predict negative returns. Our results therefore support the argument that failures occur because short sellers have given up on predicting price reversals.
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