Short Selling and the News: A Preliminary Report on an Empirical Study

Abstract

This paper examines the so far unexplored relationship between short selling and news. It starts with a theoretical analysis of short selling’s potentially beneficial and harmful effects, a brief history of its regulation and a review of the existing empirical literature. The study that follows uses daily NYSE short sale trading data representing a total of 2.3 million firm days and a measure negativity of firm news based on a content analysis of the Dow Jones Newswires. One major finding is that on trading days when there is an abnormally high level of short selling, there is a heightened level of negative news about the issuer in the non-trading hours that follow. A second finding is that where an issuer is the subject of negative news in the non-trading hours between one trading day and the next, the share price reaction when trading resumes is less pronounced where there has been an abnormally high level of short selling the day before. An analysis of our findings suggests that three news related types of short selling - traders who sell short after obtaining confidential information that an issuer is about to make a negative announcement, traders who sell short and then spread false stories, and traders who, by collecting and analyzing publicly available data, detect that an issuer’s share price exceeds its fundamental value, sell short and then truthfully spread their conclusions - are, in the aggregate, significant relative to the total amount of short selling in the market. This aggregate significance appears to come at least in part from the true and false news spreading types of short selling, not just from short selling based on confidential information concerning an impending corporate announcement.