Daily short covering activity and the weekend effect: Evidence from Taiwan

Abstract

By using a unique dataset of daily short covering volumes obtained from the Taiwan Stock Exchange, we first examine, in general, what drives daily short covering activity in the cross-section and its return predictability; we then investigate, in specific, the relation between short covering and the weekend effect. In general, we find that short covering activity is positively related to short selling activity; and short sellers on average are contemporaneous contrarians. Large-cap stocks, growth stocks, high-price stocks and stocks with high institutional ownership generally have greater short-selling and short-covering activities. We present evidence that regardless of firm characteristics, short-sellers are capable of identifying stocks whose prices tend to decline when they initiate short positions. However, the ability of short sellers to successfully cover their positions is less clear. In specific tests of the weekend effect, we find that when short covering activity is relatively high, Friday returns are more negative. Furthermore, firms with high short selling activity have a larger Monday return compared to firms with low short selling activity. Our findings are contrary to the hypothesis proposed by Chen and Singal (2003), but consistent with the notion that short sellers are contrarian in contemporaneous stock returns.