Determinants of Short Interest Trading

Abstract

Short selling is an investing strategy growing in importance, but with detractors who fear that the strategy can disrupt markets. Despite the volume of research on the effects of short selling, very little work has sought to understand the factors that determine the amount of short selling. This article explores which factors best explain the amount of shorting activity. The authors introduce a new variable that measures the relative price change in a company’s equity. Using NASDAQ company level data for the period from 2007 to 2013, they test the importance of volume, percentage price change, and relative price change to explain the number of shares shorted. All three variables are significant determinants of shorting activity. A large enough increase in industry prices may negate the effect of the increase in a company’s own share price on short-selling activities. If the average industry price change is larger than the change in the company’s share price, short sellers are less attracted to the company. Trifurcation (into high, medium, and low values) of the three primary independent variables yielded additional information on their effects on shorting activities. The authors find size-related monotonic relationships between two of their three primary variables and short selling—volume compared with shares outstanding and percentage price change. Relative price change does not support a monotonic relationship, but the differences between the subcategories are small. They also test the importance on short-selling activities of the rate of change in the overall NASDAQ market. High and low rates of change in overall NASDAQ prices do not affect short selling, but the middle range with a flat market reveals an increase in short selling. Flat markets appear to be the short-sellers’ sweet spot.

TOPICS: Fundamental equity analysis, portfolio construction