What Determines Short Interest Level?

Abstract

In the past two decades the short selling activity is rapidly increasing in the NYSE and NASDAQ. For example, in the NYSE and the NASDAQ from 1988 to 2002, the annual growth rate of short interest in both equity markets was more than 20 percent per year. In recent years, there have been a number of studies on short selling. But very few papers test the various trading hypotheses of the short-sellers as well as provide a comprehensive study to determine the factors which affect the short interest level. In this paper I attempt to answer four questions. Firstly, which set of factors systematically affects short interest level? Secondly, which factor contributes the most to explaining the short interest level? Thirdly, is there any difference in the determinants of the short interest level between the NYSE and the NASDAQ? Fourthly, is there any difference in the determinants in bubble and non-bubble periods? The main findings of the paper are as follows. First, empirical results support the Follow the Trend Hypothesis, Overpricing Hypothesis, and the Hedging and Arbitrage Hypothesis. Evidence on taxation based short-sale around the end of the year is mixed. Second, ANOVA analysis shows the borrowing costs contribute the most to explain the short interest level in the NASDAQ, but in the NYSE the arbitrage and hedging demand and the difference of investors' opinion have the largest explanation power. Third, short-sellers' behaviours are consistent in the bubble and non-bubble periods which shows they are calm traders and less affected by market sentiment.