1 Aggregate Short Selling during Earnings Seasons Paul Brockman, Lehigh University Andrew Lynch, University of Missouri Andrei Nikiforov, Rutgers University

2 Reading Questions What is the pattern of aggregate short selling activities around earnings seasons? Is aggregate short selling driven primarily by informational or non-informational (e.g., hedging) motives? Is there difference in aggregate short selling across US exchanges? Is there difference in aggregate short selling for firms in different size groups?

3 Short Selling Motives 1) Information-driven short selling: Short sellers possess firm-specific information and want to take advantage of it. 2) Hedging-based short selling: Investors and market makers use short selling to hedge their positions.

4 Aggregate Short Selling Both information-driven short selling and hedging-based short selling show similar aggregate patterns around earnings announcements:  Clustering of firm-specific information releases will concentrate information-driven short sales.  Sharp changes in liquidity, volume, and volatility will concentrate hedging-based short sales.

5 Is it information or hedging? Look at behavior of aggregate short selling for groups of firms based on:  Size  Exchange  Analyst coverage

6 Findings (1) We find that short selling is very prevalent on US stock markets. Almost 25% of all trading activity is based on short selling.  This result is consistent with other recent studies on short- selling.  It is inconsistent with the notion of widespread “short-sale constraints.”

7 Findings (2) Aggregate short-selling exhibits strong dynamic behavior around earnings seasons:  It sharply increases in the first two weeks of earnings seasons.  It tapers off over time as traders close out their positions.  These dynamic patterns are mostly focused on medium-sized firms.

8 Findings (3) The trading venue (i.e., exchange) affects the aggregate pattern of short selling activities:  Only NASDAQ stocks (48% of the sample) experience a surge in short selling at the beginning of earnings seasons.  NYSE stocks experience a slight decline in shorting activity one week prior to earnings seasons.  NASDAQ stocks experience significant decreases in short selling toward the end of the seasons.

9 Findings (4) To distinguish between information-driven and hedging-driven motives, we use analyst dispersion forecasts:  If information drives short selling, then stocks with higher dispersion will have more short sales – all else equal.  We find that the extent of short selling is independent of the dispersion of analysts forecasts.

10 The effect of the SEC “10% Rule” The rule states that when the stock’s price falls by 10% in a single day, short selling is permitted only if the sales price is higher than the best available bid price.  This rule does not affect the empirical results for our sample.  However, in our sample (01/2005 – 06/2007) only 0.34% of all firms had declines of 10% of more.  In later periods (e.g. 08/ /2009), almost 6% of firms experienced such declines. The rule might be effective in stressful market conditions.

11 Conclusions Aggregate short selling exhibits strong dynamics around earnings seasons. Aggregate short selling increases sharply in the first two weeks of earnings seasons and tapers off over time. The pattern is limited to medium-sized NASDAQ stocks. Aggregate short selling is independent of analyst following which suggests that short selling during the earnings season is motivated more by the needs of hedgers than by the possession of private information. The SEC 10% rule might be effective when market volatility is above its historical average.