Skewness, Short Interest, and the Efficiency of Stock Prices

Abstract

In this study, we examine the relationship between return skewness, short interest, and the efficiency of stock prices. Given that preferences for skewness have been shown to impact asset prices, we examine how skewness relates to market efficiency. We find that stocks with positive skewness and/or idiosyncratic skewness are less efficient than other stocks, which might be explained by overvaluation caused by investor preferences for positive skewness. Next, we document that short interest reduces both total skewness and idiosyncratic skewness. Finally, while prior research has shown that short selling can improve the efficiency of markets generally, we show that short interest’s ability to improve market efficiency is strongest in stocks with the highest skewness.