Abstract
This thesis consists of three standalone studies in the field of short selling and its impact on asset pricing. The first study investigates the trading behaviour of institutional and retail short sellers on the days of the extreme market down days in the cross-section of stock returns. It shows that both institutional and retail short sellers trade more aggressively on the extreme market down days, suggesting short sellers forego their usual contrarian role and instead follow the crowd. This indicates a tendency to follow the market during such periods. Trading with the market on days of market downturns is economically profitable for retail and institutional short sellers. An increase in retail and institutional short selling on days of extreme market downturn is associated with a measure of overpricing. This indicates that both retail and institutional short sellers follow valuation-based trading on days of market-wide declines. Thus, Short sellers contribute to correcting mispricing and promoting market efficiency by targeting overpriced stocks on extreme market down days. Given an ongoing regulator’s interest in the short sellers’ trading behaviour during market-wide declines, this finding has important regulatory implications.
In the second study, I find that retail short-covering trades negatively predict stock returns in the Taiwanese equity market. The findings indicate that retail short sellers tend to close their positions prematurely. Retail short sellers cover their positions in response to adverse price movement and equity loan fee increases, suggesting that the limits-to-arbitrage alter their behaviour around short coverings. As a result, overpricing persists, and prices continue to fall after retail short sellers exit their positions. This finding suggests that adverse market conditions force retail short sellers to cover.
In the third study, I find that retail and institutional short sellers predict negative returns in the Taiwanese equity market. The evidence suggests, however, that retail and institutional short sellers differ in their trading strategies. While retail short sellers exhibit contrarian trading behaviour, stepping in response to price run-ups, institutional short flows fall after periods of positive returns. Retail short sellers' trading pattern is consistent with trading on short-term overreaction. I also find that retail and institutional short sellers step in as voluntary liquidity providers at the time of buying pressure. I find that retail and institutional short sellers’ trading strategies pay off. The increased short selling of both investor types predicts negative abnormal iii future returns at the portfolio level for up to four trading days. I also find that retail short selling predicts a subsequent decline in buying pressure. This finding is consistent with retail short sellers' voluntary liquidity provision as a dominant trading strategy.