Working Paper: NBER ID: w21166
Authors: Harrison Hong; Weikai Li; Sophie X. Ni; Jose A. Scheinkman; Philip Yan
Abstract: The short ratio - shares shorted to shares outstanding - is an oft-used measure of arbitrageurs’ opinion about a stock’s over-valuation. We show that days-to-cover (DTC), which divides a stock’s short ratio by its average daily share turnover, is a more theoretically well-motivated measure because trading costs vary across stocks. Since turnover falls with trading costs, DTC is approximately the marginal cost of the shorts. At the arbitrageurs’ optimum it equals the marginal benefit, which is their opinion about over-valuation. DTC is a better predictor of poor stock returns than short ratio. A long-short strategy using DTC generates a 1.2% monthly return.
Keywords: short selling; arbitrage; stock returns; trading costs
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| short ratio (SR) (G19) | ease of trading (F10) |
| days to cover (DTC) (Y10) | arbitrageurs' opinion on stock overvaluation (G19) |
| days to cover (DTC) (Y10) | poor stock returns (G17) |
| days to cover (DTC) (Y10) | low expected stock returns (G17) |
| DTC outperforms SR (C52) | prediction of stock returns (G17) |