Perceived information, short interest, and institutional demand

Abstract

Abstract We test whether institutional investors’ demand relates to past arbitrage activity in the form of short interest. We find that changes in short interest positively predict institutional demand. Examining the reason for the positive relationship, we find that institutions do not appear to demand securities following increases in short interest to gain information. The securities in which the institutional demand following changes in short interest is concentrated, namely, securities with high short interest levels, low information uncertainty, and large increases in short interest, both earn returns equal to their risk-adjusted benchmarks and seem to have the least risky and most profitable share lending. The results are consistent with the idea that institutions place importance on share lending, leading to the predictability of institutional demand. Our study provides new evidence linking the behavior of professional money managers to that of sophisticated investors, such as short sellers.