Authors: Messod Daniel Beneish, Indiana University Bloomington – Department of Accounting;
Charles M.C. Lee, Stanford University – Graduate School of Business; Craig Nichols, Syracuse University
Paper Date: November 15, 2013
Rock Center for Corporate Governance at Stanford University Working Paper No. 165
Abstract: We use detailed security lending data to examine the relation between short sale constraints and equity overvaluation. We find that stocks’ “special” status exhibits a non‐linear (U‐shaped) relation with their short interest ratio (SIR), and that a stock’s special status, rather than its SIR, predicts negative returns. We show that short‐sellers trade on a variety of firm characteristics and against high sentiment. Specifically, we find: (1) the abnormal returns to the short‐side of nine market ‘anomalies’ identified in prior work are attributable to special stocks; and (2) future negative returns to special stocks are directly related to the lendable inventory in each stock rather than to its shares borrowed. Overall, our results suggest returns to the short side of documented ‘anomalies’ may not be obtainable without significant cost, and that the supply (available inventory) of lendable shares is the primary binding constraint to informational arbitrage in the case of equity overvaluation.
Keywords: Short Selling, Overvaluation, Market Efficiency