Do Short Sellers Exploit Investors’ Under- and Overreactions?

Abstract

We examine if short sellers’ reaction to current earnings surprise can be explained by cross-sectional differences in a history of earnings surprises (earnings momentum) or value-glamour characteristics. This study is motivated by our findings that short sellers tend to increase their short positions after both negative and positive earnings surprises, which is anomalous in terms of a post-earnings-announcement-drift (PEAD) story. First, we provide evidence on short sellers’ exploitation of earnings momentum after earnings announcements by showing that short sellers strongly increase their activity in negative-surprise stocks with past positive earnings surprises. Second, when we limit our analysis only to null-surprise stocks, we find that short sellers strongly increase their positions in the null-surprise stocks with past positive earnings surprises, which are likely to be followed by price reversals. Third, we investigate if short sellers increase their short positions in glamour stocks which are associated with investors’ under-reaction (overreaction) to negative (positive) earnings surprises. As expected, the results show that short sellers strongly increase their transactions in glamour stocks following both negative and positive earnings surprises. The overall results provide indirect implications on short sellers’ exploitation of market mispricing driven by investors’ under- and overreactions during the post-announcement period.