Short interest and aggregate stock returns

We show that short interest is arguably the strongest known predictor of aggregate stock returns. It outperforms a host of popular return predictors both in and out of sample, with annual R2 statistics of 12.89% and 13.24%, respectively. In addition, short interest can generate utility gains of over...

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Bibliographic Details
Published inJournal of financial economics Vol. 121; no. 1; pp. 46 - 65
Main Authors Rapach, David E., Ringgenberg, Matthew C., Zhou, Guofu
Format Journal Article
LanguageEnglish
Published Amsterdam Elsevier B.V 01.07.2016
Elsevier Sequoia S.A
Subjects
Cash flow
Cash flow channel
Equity risk premium
Informed traders
Predictive control
Predictive regression
Rates of return
Short interest
Short sales
Studies
Equity risk premium
Predictive regression
C58
Short interest
Informed traders
G12
G14
Cash flow channel
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Summary:We show that short interest is arguably the strongest known predictor of aggregate stock returns. It outperforms a host of popular return predictors both in and out of sample, with annual R2 statistics of 12.89% and 13.24%, respectively. In addition, short interest can generate utility gains of over 300 basis points per annum for a mean-variance investor. A vector autoregression decomposition shows that the economic source of short interest’s predictive power stems predominantly from a cash flow channel. Overall, our evidence indicates that short sellers are informed traders who are able to anticipate future aggregate cash flows and associated market returns.
ISSN:0304-405X
1879-2774
DOI:10.1016/j.jfineco.2016.03.004