Short selling and stock price crash risk

Jay M Chung,Shu-Feng Wang

doi:10.1108/jdqs-04-2020-0005

Abstract

This paper aims to investigate short selling and stock price crash risk. The authors find that short selling is positively associated with one-month-ahead stock price crash risk, consistent with the literature showing that short sellers are informed traders. The authors attribute this prediction ability to the information short sellers receive from foreign investors with high levels of ownership in a firm. The results shed light on policy issues regarding short selling regulation.

Highlights

Prior studies show that short sellers are considered well-informed, sophisticated traders (Diamond and Verrecchia, 1987; Asquith and Meulbroek, 1995; Asquith, Pathak and Ritter, 2005; Desai et al, 2006; Boehmer et al, 2008; Diether et al, 2009)
We investigate whether foreign short sellers, which are known as informed traders, in an emerging market are able to predict stock price crash and their sources of information
3.3 Regression analysis In the portfolio analysis, we show that the significantly positive relation between short selling activity and one-month-ahead stock price crash risk suggests that short sellers predict stock price crash

Summary

Introduction

Prior studies show that short sellers are considered well-informed, sophisticated traders (Diamond and Verrecchia, 1987; Asquith and Meulbroek, 1995; Asquith, Pathak and Ritter, 2005; Desai et al, 2006; Boehmer et al, 2008; Diether et al, 2009). We investigate whether foreign short sellers, which are known as informed traders, in an emerging market are able to predict stock price crash and their sources of information. We first examine whether short sellers predict stock price crash and identify the source of their information. One possible source of information is tips received from foreign investors with high shares of ownership in a firm. We hypothesize that short sellers shorting a stock with a high level of foreign ownership are more likely to predict stock price crash. We find the ability to predict short selling only in stocks with high levels of foreign ownership, suggesting that short sellers receive firm bad news from foreign investors with high shares of ownership in those firms.

Sample construction

Stock price crash risk

Findings

Conclusion