Have Short Sellers Become More Sophisticated? Evidence from Market Anomalies

Abstract

We examine how short sellers exploit anomaly-based trading strategies over time. While they increasingly use anomaly-based strategies to short overpriced firms, they even more intensively use these strategies to avoid underpriced firms. Over the entire sample period, short arbitrage of market anomalies fully explains abnormal returns to highly shorted stocks. However, market anomalies help shorters to avoid shorting wrong firms only in the early years, which is in contrast to recent years when non-anomaly strategies are increasingly used to avoid potential losses. Short interest increasingly contains more return predicative information beyond anomalies, and average investors are better off when trading on both anomalies and short interest and even more so in recent years. The evidence suggests that while short sellers continue to use anomaly signals over time, they have become more sophisticated in that they explore more non-anomaly signals to improve performance in recent years.