Abstract
For a sample of 356 LSE stocks from the period 2013–2019, we find that common short sold capital is positively and significantly associated with one-month ahead four-factor residual return correlation, controlling for many pair characteristics, including similarities in size, book-to-market, and momentum. The relation weakens with stock illiquidity, whereas it strengthens when short positions originate from informed agents, such as hedge funds, active investors, and short sellers with high past performance. This supports our hypothesis that the relation is driven by information, not price pressure. We show that these results can be used to obtain diversification benefits.
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