Can Short Sellers Inform Bank Supervision?

Abstract

We investigate the timeliness and accuracy of supervisory information and short seller signals to assess whether short sellers have the potential to inform bank supervision. We find that short interest in bank equity increases prior to supervisory ratings downgrades but does not decrease prior supervisory ratings upgrades. Our tests of the relative forecasting accuracy of short seller signals and supervisory ratings indicate short sellers accurately assess the changes for both deteriorating and improving bank fundamentals, but do not focus on the same fundamental variables as regulators. Our results indicate that short seller signals have the potential to complement bank supervision in monitoring bank risk.