No Relationship Between Shorting and Stock Prices

We examined two sets of stock and short interest data.

Firstly, constituent stocks of the Dow Jones Industrial Average as at January 1999 and their short interest ratios were examined from January 1999 to September 2008.

Secondly, the New York Stock Exchange (NYSE) Composite Index and the NYSE short interest ratio were examined from February 1995 to September 2008. These periods covered both bull and bear market phases.

In both cases we set out to quantify the relationship between changes in short interest ratio in month N and changes in security or index price in months N, N+1, N+2, N+3 and N+6.

We found the following:

1. There was no statistically significant relationship between changes in short interest ratios in a month and changes in stock prices in the same month or over one, two, three or six month lags for stocks in the Dow Jones Industrial Average over the period January 1999 to September 2008. It does not appear that short selling has caused stock price declines in this data universe.
2. There was no statistically significant relationship between changes in the NYSE short interest ratio and changes in the level of the NYSE Composite Index over the same month or over lags of one, two, three or six months for the period February 1995 to September 2008. Again, it does not appear that short selling has led to declines in stock prices in US stocks.
3. Increases in short selling were not associated with higher stock market volatility.

Overall, for the world’s largest stock market covering some 60% of the market capitalisation of global equities, we did not find any evidence that short selling causes securities prices to fall or to become more volatile.

We would encourage further research in this area to verify or refute our findings, but in the absence of contradictory research it appears that the most reasonable hypothesis is that the large declines in stock prices over recent months have been the result of the liquidation of securities holdings by mutual fund, institutional and retail investors and have not been the result of the actions of short sellers.

Further, the introduction of restrictions on short selling is causing significant redemptions from equity long/short hedge funds, which are generally long-biased, and is thus increasing downward pressure on stock prices as these funds are forced to liquidate positions to meet those redemptions.

In a textbook example of unintended consequences, regulatory actions to restrict short selling are themselves likely to depress stock prices.

Comments

[William Feader:]

I think you have a great idea, but the timing it too early right now. There will no doubt be another market drop soon and everyone will once again run to treasuries.

Jan 13 07:10 AM

[kruser53:]

I have always felt that shorting should have no more affect on prices than buying. Good study to provide some evidence on the subject.

Jan 13 07:38 AM

[jksinvest:]

Your study is biased and flawed, a simple comparison of the VIX volatility index which has tripled on average and the 3 fold increase in short interest since jun 2007 (lifting of the uptick rule) clearly reflects short selling causing an extreme increase in volatility, not to mention the bear raids destruction of the financials (BSC,LEH,AIG,FNM,FRE,C... Short Selling is the cancer of capitalism. It unfairly depresses valuations buy increasing shares for sell. This robs a company from rasing capital. E101 increase supply and you will see falling prices. Short selling (naked and manipulative most notably) is the true cause of the severity of this current crisis. The ability of companies to recapitalize has been taken away by the shorts, leaving only the TARP and taxpayers to pick up the pieces. pathetic.

Jan 13 08:18 AM

[jksinvest:]

You provide no evidence for these false statements and do not even disclose who you are.
But you are clearly biased and completely wrong.
Seeking Alpha should be ashamed to publish such dribble.

Jan 13 08:22 AM

[Partly Sunny:]

What are your credentials? Can you provide a link to more details on the methodology of the study? Who do you work for? Who funded the study? Do you or your sponsors profit from shorting?

Causality is often difficult to prove. You say: "we did not find any evidence that short selling causes securities prices to fall or to become more volatile." Did you find any evidence that it does not?

Micro caps are easy to manipulate, as the "caps" grow, the harder it is to manipulate -- but that doesn't mean it doesn't exist. It's just harder to prove.

Jan 13 09:27 AM

[kruser53:]

The author and all commenters are confusing cause and effect. They have not been determined. Did increased short selling cause higher volatility or occur because of it? No one has answered this question and no one will, definitively, because there is no experimental control. We have no identical parallel market where short selling was not allowed to compare to.

We all have our opinions, and mine disagree with most of the commenters. But that is what we are talking about - opinions. Nothing more.

Derrick Sicklen - - -

Your article is weak because you do not show your data and allow readers to see the details of you calculations. I find nothing fundamentally wrong in your conclusions based on what you have published, but the amount of detail necessary for considered review is missing.

Jan 13 10:25 AM

[hrant:]

you are WRONG !!! Shorting caused the collapse of major companies . after years of investing ,I now realize the small investor has little chance of winning with the current NO regualtions .

Jan 13 11:42 AM

[jorida:]

This article only makes statements without providing any evidence and seems to be a publicity paper to defend shorting. Enough evidence is available to show that concerted naked shorting with the help of Wall Street brokers have destroyed companies without any economic reason. This practice should be condemned by serious investors and put into the same box as the Ponzi schemes.

Jan 13 12:05 PM

[John Lounsbury:]

rkruse52, you are exactly right. People see A happen and B happen at about the same time. Did one cause the other? Or is it just a coincidence? It takes controlled experimentation to determine cause and effect. Otherwise the assignments are by implication, not proof. Also I agree the author should show more data and methodology.

jorida, I have the same cause and effect point for your comment. Now, that said, naked shorting should not be allowed because of the potential for abuse. Note: I did not say because it has been abused. Proof of that has yet to be presented.

It has been argued that naked short selling is necessary for market makers to have all the resources necessary to maintain stable markets. If that argument has merit, it should be required that naked short positions be closed in the same trading day they are opened. I think now they are allowed several (two?) days. That is too long.

Short selling in and of itslf has many good uses. I often use "shorts against the box" to protect long-term holdings in times of volatility. Sometimes a client owns something experiencing volatility that is outside the client's comfort zone. Shorting stock that is also owned is often a much less expensive way to hedge against loss than buying put options. Sometimes the client owns restricted stock (employer grants that have a future date required before they can be sold). The client's equity can be protected until the restrictions retire.

Jan 13 12:38 PM

[akasidney:]

With the same study parameters, do you think you'd find any relationship between buying and stock prices? You're a joke.

Jan 13 12:42 PM

[amdman:]

The "NYSE short interest ratio" is a joke as Jim Cramer on Mad Money pointed out. The REAL short numbers are private and cost big money to get access to.
This article is paid for spam from some hedge fund that shorts. (At least half the real news you read is leaked by some fund that wants to move a stock.)

Jan 16 04:34 PM

[Relativist:]

There is a link to the research paper. It's at:

www.platypuscap.com/re...

It would be interesting to get feedback from this group once members have read it.

Jan 19 08:23 PM