Short-selling Activity and Return Predictability: Evidence from the Chinese Stock Market

ABSTRACT

We examine the informativeness of short selling in the Chinese stock market based on monthly and daily short-interest data from January 2011 to July 2018. We find that short selling negatively predicts future stock returns in China. The pattern is robust when controlling for firm size, book-to-market ratio, and liquidity. A long-short strategy using a short-interest ratio (SIR)—shares shorted to shares outstanding—generates a 0.865% monthly return. We also document that return predictability is stronger when short selling is restricted. Meanwhile, we examine the information content of short-selling activity, and we confirm that the significant negative relationship between preannouncement short activity and post-announcement period returns.

KEYWORDS:

• Chinese stock market
• short selling
• earnings announcements
• return predictability

JEL:

• G14
• G15
• C14

Notes

1. Autore, Billingsley, and Kovacs (2011) report that 797 financial stocks were banned from short selling for 14 trading days (from September 19, 2008 to October 8, 2008).

2. As shown in Figure 1, the average short-interest ratio (SIR) is approximately zero prior to 2011.

3. In unreported results, we find that the interaction term between SIR and firm size is positive and significant when it is tested separately with other two interaction terms for both of the sample periods.

4. D’Avolio (2002), Asquith, Pathak, and Ritter (2005) and Nagel (2005) employ institutional ownership as a proxy for the supply of lendable shares and find it is highly correlated with the cost of shorting.

Additional information

Funding

Dr. Dan Luo would like to acknowledge the financial support provided by the National Natural Science Foundation of China [71672010]. Dr. Ningru Zhao would like to acknowledge the financial support provided by the Natural Science Foundation of Jiangsu Higher Education Institutions [15KJB180008]. Dr. Lanlan Liu would like to acknowledge the financial support provided by the Applied Economics of Nanjing Audit University of the Priority Academic Program Development of Jiangsu Higher Education Institutions (Office of Jiangsu Provincial People’s Government, No. [2018] 87).