The Profits and Losses of Short Sellers

Abstract:

We characterize the profits and losses experienced by short sellers on a large cross-section of U.S. stocks. By using a novel dataset, we establish that short sellers incur losses on the average short position, but make profits on heavily-shorted stocks and on small, hard-to-borrow stocks. Current performance feeds back into future short selling. Short sellers experiencing losses in excess of 15% substantially reduce their positions, as if affected by capital constraints. Loss-making short selling is relatively less informed, as the well-documented predictive power of short interest for future returns falls with the fraction of short sellers experiencing losses. We conclude that even though short sellers are affected by constraints, limits to arbitrage are mitigated as the constraints apply predominantly to the uninformed.

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