WHAT CAN WE LEARN ABOUT SHORT SELLERS’ INDUSTRY TRADES

Abstract

While most institutional traders follow specific strategies, such as value, size, or industry strategies, there is little evidence on a specific group of institutions, short sellers’ strategies, specifically whether short sellers prefer specific industries. Since at the stock level, short sellers focus on overvalued and less transparent stocks where their superior information processing skills can generate substantial returns, it is plausible that they prefer industries with high concentration of these types of stocks. In this study, I show that short sellers have strong preference for specific industries and while there is some time series variation in their preferences, a handful of industries are generally account for half of the outstanding shorting demand. In addition, I find that short sellers were able to predict the decline of the housing and the mortgage industries, as they steadily increased their positions in these industries two years prior to the crisis. I also show that the short sale ban had a market wide impact, resulting in a decline in shorting in almost all industries, not only in the financial sector. These results suggest that the shorting ban had an important adverse spillover effect as with lower level of shorting, the price discovery tends to be slower which in turn may resulted in the expected recovery of the US equity market taking longer.