The short-selling skill of institutions and individuals

Texto

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The Short-selling Skill of Institutions and Individuals

Fernando Chague

, Rodrigo De-Losso

, Bruno Giovannetti

§

July 3, 2017

Abstract

Using market-wide data from the Brazilian stock lending market, we find strong evidence of short-selling skill among institutions and individuals. Skilled short-sellers present out-of-sample performance persistence, both over time and across stocks. Per-formance persistence is robust: by randomly splitting the sample across stocks, we show that performance in a group of stocks often predicts performance in another group of stocks. We then study how skilled short-sellers trade. We find that most of their profit does not come from firm-specific private information, they follow short-term momentum strategies, and they do not display the disposition effect.

JEL Codes: G12, G14.

Keywords: short-selling, skilled investors, out-of-sample performance, short-term momentum, disposition effect

An early version of this paper was previously circulated under the title ”Uncovering Skilled Short-sellers.”

We thank Fl´avio Abdenur, Marco Bonomo, Marcelo Fernandes, Bernardo Guimar˜aes, Marcos Nakaguma, Walter Novaes, Pedro Saffi, Jos´e Carlos de Souza Santos, and participants at seminars in the S˜ao Paulo School of Economics at Get´ulio Vargas Foundation and in the Lubrafin 2017 meeting for their valuable comments. We also thank Eduardo Astorino and Elias Cavalcanti for excellent research assistance.

Sao Paulo School of Economics, FGV, Brazil. E-mail: fernando.chague@fgv.br.Department of Economics, University of Sao Paulo, Brazil. E-mail: delosso@usp.br.

§Sao Paulo School of Economics, FGV, Brazil. Corresponding author at: Rua Itapeva, 474. CEP

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1

Introduction

The existence of skilled investors who can consistently beat the market is still

contro-versial.1 In this paper, we focus on a particular type of investment skill: short-selling skill.

Short-selling is an important trading strategy that accounts for a large fraction of traded

volume.2 We present in- and out-of-sample evidence of short-sellers, both institutions and

individuals, who can consistently beat the market.

Focusing on selling skill has two advantages. First, selling deals are short-lived bets with well-defined outcomes. Since a typical short-seller places many of these bets in a year, we can measure performance with few years of data. Second, once we compute performance at the deal-level (instead of at the portfolio level, as usual), we are able to split the data set both over time and across stocks to study out-of-sample performance persistence. That is, besides studying if past performance predicts future performance (persistence over time), we can also study if performance in one group of stocks predicts performance in another group of stocks (cross-sectional persistence). Importantly, since stocks can be divided in an arbitrary number of different ways, we can analyze the robustness of cross-sectional performance persistence.

Documenting the existence of short-selling skill among both institutions and individuals naturally contributes to the extensive and still active literature that searches for investment

skills among market participants.3 However, we contribute more directly to the specific

lit-1According to Berk and van Binsbergen (2015), “an extensive literature in financial economics has focused

on the question of whether stock picking or market timing talent exists. Interestingly, the literature has not been able to provide a definitive answer to this question.”

2According to Diether, Lee, and Werner (2009), short-sales were responsible for 24% of NYSE volume

and 31% of Nasdaq volume by 2005. Nowadays these shares should be higher. In Brazil, the volume share of short sales ranges from 18% to 39% during our sample period (2012 to 2014).

3For mutual funds, the empirical evidence from the early 90’s is favorable to the existence of performance

persistence (Lehmann and Modest, 1987, Grinblatt and Titman, 1992, Goetzmann and Ibbotson, 1994, Brown and Goetzmann, 1995, and Elton, Gruber, and Blake, 1996). However, following studies show that performance is unpredictable once mutual fund expense ratios and momentum in stock returns are taken into account (Carhart, 1992, 1997, Gruber, 1996, Zheng, 1999, Wermers, 2000, Bollen and Busse, 2001). In turn, Berk and Green (2004) argue that performance persistence should be hard to be detected even in the presence of skill due to managers decreasing returns to scale. More recently, by looking at the monetary value of fees collected by funds, Berk and van Binsbergen (2015) provide favorable evidence of skilled managers. Crane and Crotty (2017) show that index funds also have skill. With respect to individual investors, Odean

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erature on short-selling. Skilled short-sellers are like reclusive celebrities: prized but elusive. Although they are highly regarded by practitioners and researchers because aggregate

short-ing predicts returns,4 very few is known at the short-seller level. Using proprietary NYSE

order data, Boehmer, Jones, and Zhang (2008) disaggregate short-selling up to investor type (individual and institution) and find that the average institution is more informed than the average individual. Using a data set constructed from occasional disclosures of very large short-selling positions in Europe, Jank and Smajlbegovic (2015) find that hedge funds out-perform other short-sellers. Using proprietary data from discount brokerage firms, Kelley and Tetlock (2017) documents that aggregate short-selling by individuals predicts lower re-turns, which suggests the existence of individuals who may be skilled short-sellers. Using data from the Korean stock market, Wang, Lee, and Woo (2017) study short-selling by in-dividuals and find that inin-dividuals who sell short more firms make higher and persistent profits.

We are the first to use market-wide data to comprehensively study short-selling skill at the investor level. We observe all 4,575,324 stock loan deals by all institutions and indi-viduals in Brazil from 2012 to 2014. For each loan contract we have the stock traded, the loan quantity, the loan fee, the brokerage rate, the short-seller type (individual or institu-tion), a unique identification variable for the short-seller, the dates when the loan contract was both initiated and effectively terminated, the date when it was originally set to ter-minate, and whether it could be terminated earlier by the borrower, by the lender, or by

both.5 We use all these variables to answer the following five questions: What proportion

(1999), Barber and Odean (2000), Grinblatt and Keloharju (2000), and Barber, Lee, Liu, and Odean (2009) find that the average performance of individual investors is poor in the long-run. However, some studies show that the returns earned by individual investors over short horizons (up to a week) appear to be quite strong (Kaniel, Saar, and Titman, 2008, Kaniel, Liu, Saar, and Titman, 2012, Barber, Odean, and Zhu, 2009), and that there is performance persistence among individual investors (Coval, Hirshleifer, and Shumway, 2005).

4Looking at aggregate shorting, Diether, Lee, and Werner (2009), Engelberg, Reed, and Ringgenberg

(2012), and Rapach, Ringgenberg, and Zhou (2016) show that the opening of short positions predicts lower returns. In turn, Boehmer, Duong, and Husz´ar (2017) show that the covering of large short-positions predicts higher returns.

5Chague, De-Losso, Genaro, and Giovannetti (2017) use a less detailed data set on the Brazilian equity

lending market which does not track the loan deal over time. They find that—for the same stock, on the same day—well-connected stock borrowers pay significantly lower loan fees, a result that relates search costs

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of institutions and individuals can consistently beat the market? Do they present robust out-of-sample performance persistence? By how much does their total profit depend on the anticipation of private firm-specific information? Do they contribute to the price discovery process by avoiding short-term price overshooting or by accelerating the incorporation of negative information into stock prices? Do they display the disposition effect when covering their positions? The goal of the first two questions is to study whether short-selling skill indeed exists at the investor level. The goal of the last three questions is to provide some understanding on short-selling skill.

We first say a short-seller is a P S-short-seller (“a potentially skilled short-seller”) if three minimum conditions are simultaneously satisfied: i) the average risk-adjusted return across her short-selling deals is positive and statistically significant, ii) her total profit from shorting is positive, and iii) she closed at least 10 distinct short-selling deals. From a total of 4,107 institutions, we classify 367 (8.9%) as P S-short-sellers (P S-institutions hereinafter). They present a high average risk-adjusted return per deal of 0.85% (or 25.5% per year, considering the median duration of a shorting deal of 12 days), and a high average return net of loan and brokerage fees per deal of 0.80% (24% p.y.). They are responsible for 31.5% of the total shorting volume and 26.7% of the total number of shorting deals. With respect to individuals, we classify 1,484 (4.2%) as P S-short-sellers (P S-individuals hereinafter) from a total of 35,338 individuals. Their performance is even better. Their average risk-adjusted return per deal is 1.70% (51.0% p.y.), while their average net return per deal is 1.59% (47.7% p.y.). They are responsible for 0.3% of the total shorting volume and 2.5% of the total number of shorting deals.

We then study the sample performance of P S-short-sellers. We conduct out-of-sample exercises along two dimensions. First, we study performance persistence over time. We classify short-sellers as P S-short-sellers in 2012 and 2013 and compute their out-of-sample performance in 2014. Second, we explore the fact that our performance analysis

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is at the deal-level to study cross-sectional performance persistence. We first split stocks based on two firm-related variables: firm size and full-sample realized return. Do short-sellers who outperform on large caps also outperform on other stocks? Do short-short-sellers who outperform on stocks that presented a negative full-sample return also outperform on stocks that presented a positive full-sample return? We then randomly split the stocks many times to evaluate whether the evidence of cross-sectional performance persistence survives even in the least favorable sample splits. We classify short-sellers as P S-short-sellers using half of the stocks and compute their out-of-sample performance on the remaining stocks. We perform this cross-sectional out-of-sample analysis in 1,000 different randomly partitioned data sets.

The out-of-sample results provide strong evidence of performance persistence among short-sellers. With respect to persistence over time, institutions that are classified as P S-short-sellers in 2012 and 2013 outperform other institutions in 2014 by, on average, 0.30% per deal (risk-adjusted). Individuals who are classified as P S-short-sellers in 2012 and 2013 outperform other individuals in 2014 by 0.44% per deal. The results are the same if we consider net or gross returns, and if we compute medians.

With respect to persistence across stocks, short-sellers who outperform on large caps also outperform on other stocks. Moreover, short-sellers who outperform on stocks that presented a negative full-sample return also outperform on stocks that presented a positive full-sample return. Cross-sectional persistence is rather robust. In our 1,000 random sample splits, in virtually all partitioned data sets, P S-short-sellers outperform other short-sellers out-of-sample. The average across the 1,000 estimates of the out-of-sample excess performance of P S-institutions is 0.31% per deal (risk-adjusted) and the 5th percentile across the 1,000 estimates is 0.14% per deal. The average across the 1,000 estimates of the out-of-sample excess performance of P S-individuals is 0.91% per deal and the 5th percentile across the 1,000 estimates is 0.71% per deal. The fact that both P S-institutions and P S-individuals continue to outperform other investors out-of-sample even in the least favorable sample splits

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(the 5th percentiles) is remarkable.

The robust out-of-sample evidence of performance persistence indicates that there is short-selling skill. Next, we study short-selling skill by examining P S-short-sellers trading activity. We answer two questions related to their ability in opening a short position and one question related to their ability in covering a short position.

According to the short-selling literature, an important portion of short-sellers superior

performance comes from correctly anticipating firm-specific news events.6 The economic

im-portance of such events to short-sellers’ profit, however, is an open empirical question which we can answer with our detailed data set. To do so, we compute the share of the P S-short-sellers’ total profit that can be attributed to these events. Since we observe both the initial and terminal dates of each deal, we can determine whether a firm-specific event did occur during the life span of the deal. Considering all P S-institutions, we find that 19.9% of their total shorting profit (US$ 2.2 billion in the 3-year period) came from deals during which a negative earning announcement occurred, 17.1% from deals during which a negative

mate-rial fact announcement7 occurred, and 3.2% from deals during which both events occurred.

Considering all P S-individuals, we find that 12.8% of their total shorting profit (US$ 50 mil-lion in the 3-year period) came from deals during which a negative earning announcement occurred, 6.9% from deals during which a negative material fact announcement occurred, and 3.4% from deals during which both events occurred. The fact that only a portion of short-sellers profit came from these two types of firm-specific events is reassuring. If this were not the case, the practice of insider trading by short-sellers could be more relevant to their profit than genuine shorting skill. This is particularly true for negative material fact 6Christophe, Ferri, and Angel (2004) find that aggregate short-selling increases few days prior to negative

earnings announcements. Engelberg, Reed, and Ringgenberg (2012) find that aggregate short-selling is particularly strong around days when firm-specific news is disclosed.

7According to Brazilian regulation, important corporate news announcements must the disclosed

imme-diately by the firm (usually referred to as “material facts”), and any company insider endowed with this information is prohibited to disclose it privately or to trade upon it. Because of their nature – largely unan-ticipated and containing important information about the firm not yet impounded into prices –, material facts are important piece of news that affects prices significantly. Examples of material facts include proposal of mergers, changes of CEOs, and announcements of secondary public offering of shares.

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announcements, which are not scheduled and should be unpredictable for company outsiders. In our second analysis of P S-short-sellers ability in opening a short position, we relate their trading activity to past movements of stock prices. Along this dimension, we can broadly characterize investors as following either a momentum strategy—i.e., the investor sells short after a stock price fall—or a contrarian strategy—i.e., the investor sells short after a stock price increase. An informed short-seller who follows a contrarian strategy would contribute to the price discovery process by avoiding short-term price overshooting. In contrast, an informed short-seller who follows a momentum strategy would contribute to the price discovery process by accelerating the incorporation of negative information into stock prices. Our results indicate that P S-short-sellers are short-term momentum traders. The results hold both in- and out-of-sample. This finding resonates with Yan and Zhang (2009) who, using publicly available data on portfolio holdings, provide evidence that skilled institutions tend to trade at short-term horizons and follow momentum strategies.

In our last analysis of shorting skill, we study the covering of a short position. One of the most robust features of unsophisticated investors behavior is the so-called disposition effect (i.e., the tendency of riding losses and realizing gains; see Barberis and Xiong, 2009). Accordingly, we test if P S-short-sellers are less susceptible to the disposition effect. To do so, we run deal-by-deal regressions of a dummy variable that indicates whether a deal was terminated earlier by the short-seller on a variable that measures the initial performance of the deal: the first 5-day stock return since the opening of the short position. A negative first 5-day return means a good start for the deal. If the short-seller responds to a good start by

anticipating the covering of the deal, she is behaving according to the disposition effect.8 As

expected, P S-short-sellers do not display the disposition effect, while other short-sellers do. The results also hold both in- and out-of-sample.

The remainder of the paper is organized as follows. In Section 2 we describe our data set and present some basic statistics concerning short-selling in Brazil. In Section 3 we present 8In 99.2% of the loan contracts in our data set the borrower has the option to return the stock to the

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evidence of the existence of short-selling skill. In Section 4 we examine P S-short-sellers trading activity to study shorting skill. Finally, Section 5 concludes.

2

Short-selling in Brazil

Short-selling is very common in Brazil. On average 25% of the traded volume comes from equities being sold short. This is similar to the number reported by Diether, Lee, and Werner (2009) for the US market in 2005 (24% for NYSE and 31% for Nasdaq). Figure 1 shows, on a monthly basis, the total number of shares traded, the total number of shares loaned, and the ratio between these two numbers.

[Figure 1 about here]

Stock lending is regulated by the Brazilian Securities and Exchange Commission (CVM); all shorting loans are registered at BM&FBOVESPA, which acts as the central-counterpart in this market. Recent articles on short-selling have explored this very detailed Brazilian equity lending market data. Chague, De-Losso, De Genaro, and Giovannetti (2014) show that aggregate shorting predicts returns in Brazil, Bonomo, Mello, and Mota (2015) test whether short-selling restrictions generate stock overpricing, and Chague, De-Losso, Genaro, and Giovannetti (2017) show that well-connected borrowers with lower search costs pay significantly lower loan fees.

2.1

Data set

Our data set contains all of the 4,575,324 equity loan contracts closed in Brazil from January 2012 to December 2014. For each loan contract we have the stock traded, the loan quantity, the loan fee, the brokerage rate, the short-seller type (individual or institution), a unique identification variable for the short-seller, the dates when the loan contract was both initiated and effectively terminated, the date when it was originally set to terminate, and whether it could be terminated earlier by the borrower, by the lender, or by both.

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We apply a single filter to the original data set. We exclude from the full sample all loan

contracts that intersect an “interest on equity” ex-date.9 According to Brazilian law, the tax

treatment of interest on equity differs according to investor type: individual investors pay a tax rate of 15%, while financial institutions are exempt. As a result, on days around the ex-date of interest on equity there are many tax arbitrage trades between individuals and financial institutions in which individuals lend shares to financial institutions at a higher loan fee. These loans deals are therefore unrelated to short-selling.

Our final working sample contains 3,341,213 loan contracts on 357 different stocks. Panel A of Table 1 displays, for each year of the sample, the total number of loan contracts and the total number of distinct short-sellers by investor type. Panel B of Table 1 exhibits some statistics on the empirical distributions of two variables, the number of loan deals closed by short-sellers and the duration (measured in calendar days) of the loan contracts. Shorting deals are mostly short-term trades: the median number of days of a loan contract in our

sample is 12 days for both types of investors.10

[Table 1 about here]

3

Is there short-selling skill?

There is solid evidence that aggregate shorting predicts future returns (see, for instance, Boehmer, Jones, and Zhang, 2008, Diether, Lee, and Werner, 2009, Engelberg, Reed, and Ringgenberg, 2012, and Rapach, Ringgenberg, and Zhou, 2016). Therefore, the short-selling market is a promising place to look for skilled investors. We directly infer the skill of a short-seller by looking at the outcomes of her shorting deals. It is like inferring the skill of a poker player by looking at how many games she wins.

9In Brazil, firms distribute cash to shareholders in the form of cash dividends, interest on equity, or a

combination of the two.

10We do not consider shorting deals that are covered on the same day (day trades), as these deals do not

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Our sample period is particularly suitable to measure short-sellers performance. Between January 2012 and December 2014, the Brazilian stock market experienced no overall trend, with high volatility. Hence, there were sufficient ups and downs for short-sellers to show their skill (or their lack of) as Figure 2 illustrates.

[Figure 2 about here]

In Section 3.1, we first classify short-sellers according to their in-sample individual per-formance. We show that some short-sellers are potentially skilled: they present good perfor-mance and high shorting activity. They are like poker players who play and win many games. In Section 3.2, we run several out-of-sample exercises to show that short-selling performance is persistent out-of sample. Back to our poker analogy, players who win some games are more likely to win other games. Taken together, these results support the existence of short-selling skill.

3.1

In-sample performance of short-sellers

To assess short-sellers performance, we first compute for each shorting deal i its realized

risk-adjusted return: Ra

i = 1 − Pi,1a /Pi,0a , where Pi,0a is the risk-adjusted price at which the

short-seller sells the stock and Pa

i,1is the risk-adjusted price at which the short-seller buys the

stock to cover the position.11 In Brazil, just as in the United States, equity transactions are

settled after three trading days, while equity loans are settled on the same day. Accordingly, a short-seller does not need to borrow a stock until the third day after taking her short position. Therefore, following Geczy, Musto, and Reed (2002) and Beschwitz, Bastian, and 11We adjust prices for risk as follows. For each stock, we first run time-series regressions of the daily

stock return on the four Fama-French-Cahart risk factors (the risk factors for Brazil were obtained at http://www.nefin.com.br). We then compound the residuals of these regressions (the idiosyncratic daily stock returns) to obtain a time-series of risk-adjusted prices of each stock.

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Massa (2015), we use in the computation of Pa

i,0 and Pi,1a the closing prices three trading

days earlier to the dates the loan contract was initiated and terminated, respectively.12

We then compute for each short-seller k the average risk-adjusted return across her shorting deals. To avoid considering different loan deals linked to the same shorting deal, we

consider at most one loan deal per investor-stock-week (randomly chosen). Let Nk be the

number of loan deals used to compute short-seller k’s average risk-adjusted return. We call

these Nk deals “distinct short-selling deals.”

Additionally, we compute for each short-seller k her total profit from shorting during the 3-year period, taking into account expenses with loan and brokerage fees. To compute

short-seller k’s total profit, we use all her loan deals (not only the Nk).

We then say that short-seller k is a “potentially skilled short-seller” (P S-short-seller) if three minimum conditions are simultaneously satisfied: (i) her average risk-adjusted return

across the Nkdistinct short-selling deals is statistically significant and positive13, (ii) her total

profit is positive, and (iii) Nk ≥ 10. Short-sellers who do not meet any of these conditions

are classified as “other short-sellers.” Among these, there should be many different types of short-sellers: sporadic short-sellers who made few bets; skilled short-sellers who were unlucky; unskilled short-sellers; and potentially skilled investors who sell short for reasons other than directional trading such as long-short strategies, hedging, and liquidity supplying. Figure 3 shows the monthly evolution of the number of stocks traded, the number of deals closed, and the average duration of the shorting deals, for the median P S-short-seller and the median “other short-seller.” The median P S-institution sells short nine different stocks per month, closes about 45 loan deals per month, and stays about 20 days in a deal, while the median “other institution” sells short three stocks per month, closes about six loan deals per month, and stays about 16 days in a deal. The median P S-individual sells short 12In 99.2% of the loan contracts in our data set the borrower has the option to return the stock to the

lender earlier than the original expiration date of the loan contract. The early return process is automatic and costless. Therefore, it is reasonable to assume that when a short-seller closes her position (buys the stock back) she also terminates the loan contract to avoid unnecessary loan costs.

13We test condition (ii) using a standard t-test considering a 10%-confidence level, with standard-errors

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two different stocks per month, closes about three loan deals per month, and stays about 17 days in a deal, while the median “other individual” sells short one stock per month, closes about two loan deals per month, and stays about 15 days in a deal.

[Figure 3 about here]

According to Table 2, from a total of 4,107 institutions, 367 (8.9%) are P S-short-sellers, and from a total of 35,338 individuals, 1,484 (4.2%) are P S-short-sellers. P S-institutions are responsible 31.5% of the total shorting volume and 26.7% of the total number of shorting deals. P S-individuals are responsible for 0.3% of the total shorting volume and 2.5% of the total number of shorting deals.

[Table 2 about here]

Table 2 also reports the average and median returns of each group. We compute three types of returns for each shorting deal: “gross returns,” which are risk-unadjusted and do not

consider loan costs;14“net returns,” which are also risk-unadjusted but do consider loan costs

(loan and brokerage fees); and “risk-adjusted returns,” which are risk-adjusted and are the same used to classify short-sellers as potentially skilled. P S-institutions present an average (median) gross return per deal of 1.12% (0.56%), while “other institutions” present 0.10% (0.00%). P S-institutions present an average (median) net return per deal of 0.80% (0.40%), while “other institutions” present 0.10% (0.00%). Finally, P S-institutions present an average

14We compute gross returns as 1 − P

i,1/Pi,0, where Pi,0 is the price at which the short-seller sells the

stock and Pi,1 is the price at which the short-seller buys the stock back. As before, Pi,0 and Pi,1 are the

closing prices three trading days earlier to the dates when the loan contract was initiated and terminated, respectively.

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(median) risk-adjusted return per deal of 0.85% (0.54%), while “other institutions” present 0.16% (0.00%). These returns are economically important given the typical length of a shorting deal (median of 12 days, according to Table 1).

In turn, P S-individuals present an average (median) gross return per deal of 1.76% (1.55%), while “other individuals” present -0.57% (-0.14%). P S-individuals present an aver-age (median) net return per deal of 1.59% (1.44%), while “other individuals” present -0.72% (-0.26%). Finally, P S-individuals present an average (median) risk-adjusted return per deal of 1.70% (1.42%), while “other individuals” present -0.20% (0.06%). The difference in the performance between P S-short-sellers and “other short-sellers” is even higher for individuals than for institutions.

Finally, Table 2 reports the average and median probability of each short-seller presenting the observed share of winning deals under the null of no skill. We count for each short-seller k

the number of deals with positive net return (Nk+) among her Nkdistinct short-selling deals.

We then use the binomial distribution to compute P Nk+; Nk, 0.5, i.e., the probability

of short-seller k presenting at least Nk+ successes in Nk trials if her success probability

in a single deal is equal to 50%. The lower P Nk+; Nk, 0.5, the higher the chance of

short-selling k having a success probability greater than 50%. P S-institutions present an

average (median) P Nk+; Nk, 0.5



of 0.09 (0.22), while “other institutions” present 0.75

(0.69). In turn, P S-individuals present an average (median) P Nk+; Nk, 0.5 of 0.11 (0.20),

while “other individuals” present 0.73 (0.67).

To illustrate performance at the individual level, Table 3 shows some statistics for the

twenty P S-short-sellers (ten institutions and ten individuals) with the lowest P Nk+; Nk, 0.5.

Column (2) presents the winning fraction computed as Nk+/Nk. The remaining columns

present for each short-seller the following variables: the number of distinct short-selling

deals, Nk, the total profit in thousands of dollars considering all deals, the average

risk-adjusted, gross, and net return across the Nk deals, and the total number of different stocks

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[Table 3 about here]

Figure 2 indicates that P S-short-sellers trade more than “other short-sellers.” This could

directly follow, however, from our imposition of Nk ≥ 10 for a short-seller to be classified

as potentially skilled. To evaluate whether P S-sellers trade more than “other sellers”, we compare P S-sellers’ trading activity with the activity of “other

short-sellers” who also have Nk ≥ 10. We regress three variables that capture different aspects

of shorting activity on a dummy variable that equals one if the short-seller is classified as potentially skilled. The dependent variables are the number of distinct short-selling deals of

each short-seller (Nk), the average volume of each deal, and the number of distinct stocks

sold short by each short-seller in the full sample.

According to Panel A of Table 4, a P S-institution closes on average 298.5 more deals than an institution that is not potentially skilled. This represents an increase of 86.1%. Moreover, the average deal volume of a P S-institution is US$ 50 thousand greater (46.7% in relative terms). Finally, a P S-institution also sells short more stocks (20.1 more stocks on average, or 60.1% more). According to Panel B of Table 4, a P S-individual closes on average 5.37 more deals than a individual that is not potentially skilled. This represents an increase of 14.2%. On the other hand, the average deal volume of a P S-individual is smaller (US$ 3 thousand smaller, 13.0% in relative terms). Finally, a P S-individual also sells short more stocks (4.9 more stocks on average, or 38.6% more).

[Table 4 about here]

Even under the null hypothesis of “no skill”, some investors would present good realized performance (type I error). The fact that P S-short-sellers display a more intense short-selling

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activity, however, goes against the “type I error story.” Nonetheless, additional evidence is certainly needed if we want to conclude that there is shorting skill. For this purpose, we next perform a number empirical exercises to show that P S-short-sellers performance continuous to be superior out-of-sample.

3.2

Out-of-sample performance of short-sellers

In this section we show that the good performance of P S-short-sellers is persistent out-of-sample. The first exercise is a standard out-of-sample analysis with respect to time. We classify short-sellers as P S-short-sellers using their deals in 2012 and 2013 and study their performance using their deals in 2014.

The second exercise explores the fact that our performance analysis is at the deal-level. We first split stocks based on two firm-related variables: firm size and full-sample realized return. We then randomly split the stocks 1,000 times to evaluate whether the cross-sectional evidence of performance persistence survives even in the least favorable sample splits.

3.2.1 Time-dimension out-of-sample

Using only the deals in 2014, we estimate the following conditional mean and median deal return E reti,k|P S 12,13 k  = π0+ π1P S 12,13 k M ed reti,k|P Sk12,13 = π2+ π3P Sk12,13

where P Sk12,13 is a dummy variable that equals one if short-seller k is classified as a P

S-short-seller considering only her deals in 2012-2013,15 and reti,k is the short-selling return

15We apply the same criteria as before: to be considered a P S-short-seller, she must have statistically

positive average risk-adjusted return across the Nk distinct short-selling deals, positive total profit, and

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(gross, net, and risk-adjusted) of deal i closed by short-seller k in 2014. Both regressions are estimated separately for institutions and individuals.

Table 5 presents the results. There is evidence of performance persistence for both

P S-institutions and P S-individuals. According to Panel A, institutions that are classified as P S-short-sellers in 2012-2013 have in 2014: expected gross return per deal of 0.609% (0.330% + 0.279%) v.s. 0.279% of institutions who are not classified as P S-short-sellers; median gross return per deal of 0.572% v.s. 0.215%; expected net return per deal of 0.380% v.s. 0.110%; median net return per deal of 0.427% v.s. 0.124%; expected risk-adjusted return per deal of 0.469% v.s. 0.171%; and median risk-adjusted return per deal of 0.523% v.s. 0.257%.

[Table 5 about here]

According to Panel B of Table 5, individuals that are classified as P S-short-sellers in 2012-2013 have in 2014: expected gross return per deal of 0.173% v.s. -0.284% of individuals who are not classified as P S-short-sellers; median gross return per deal of 0.532% v.s. 0.108%; expected net return per deal of 0.004% v.s. -0.433%; median net return per deal of 0.423% v.s. 0.001%; expected risk-adjusted return per deal of 0.326% v.s. 0.084%; and median risk-adjusted return per deal of 0.552% v.s. 0.276%.

According to these results, short-sellers classified as potentially skilled in 2012-2013 present in 2014 a better performance than the ones not classified as potentially skilled in 2012-2013. To provide further evidence of performance persistence, we next take advantage of our deal-by-deal data to conduct out-of-sample exercises across stocks.

3.2.2 Stock-dimension out-of-sample: size and full sample return

The fact that our measure of performance is computed at the deal-level (as opposed to at the portfolio level) allows us to split the sample across stocks. In our first cross-sectional

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out-of-sample exercise, we split stocks based on two firm-related variables: firm size and full-sample realized return. Do short-sellers who outperform on large caps also outperform on other stocks? Do short-sellers who outperform on stocks with negative full-sample return also outperform on stocks with positive full-sample return?

With respect to firm size, we rank all stocks in our sample according to their average market capitalization and assign the top 20 stocks to the group Big. Then, using only deals on stocks that are not in the group Big, we estimate

Ereti,k|P SBigk

 = π0+ π1P SBigk M edreti,k|P S Big k  = π2+ π3P S Big k

where P SkBigis a dummy variable that equals one if short-seller k is classified as a P

S-short-seller considering only her deals on stocks from group Big, and reti,k is the short-selling

return (gross, net, and risk-adjusted) of deal i closed by short-seller k on stocks that are not in the group Big. Both regressions are estimated separately for institutions and individuals.

[Table 6 about here]

Table 6 present the results. There is evidence of performance persistence for both P S-institutions and P S-individuals. According to Panel A, S-institutions that are classified as P S-short-sellers within Big stocks have on other stocks: expected gross return per deal of 1.293% (0.719% + 0.574%) v.s. 0.574% of institutions who are not classified as P S-short-sellers; median gross return per deal of 0.665% v.s. 0.229%; expected net return per deal of 0.851% v.s. 0.262%; median net return per deal of 0.464% v.s. 0.077%; expected risk-adjusted return per deal of 0.837% v.s. 0.398%; and median risk-risk-adjusted return per deal of 0.554% v.s. 0.292%.

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According to Panel B of Table 6, individuals that are classified as P S-short-sellers within Big stocks have on other stocks: expected gross return per deal of 0.311 (0.629% - 0.318%) v.s. -0.318% of individuals who are not classified as P S-short-sellers; median gross return per deal of 0.564% v.s. 0.000%; expected net return per deal of 0.142% v.s. -0.523%; median net return per deal of 0.438% v.s. -0.050%; expected risk-adjusted return per deal of 0.568% v.s. -0.027%; and median risk-adjusted return per deal of 0.712% v.s. 0.278%.

With respect to full-sample realized return, we call the stocks with negative cumulative return over 2012-2014 as Losers. Then, using only deals on stocks that are not in the group Losers, we estimate

E reti,k|P SLosersk  = π0+ π1P SLosersk

M ed reti,k|P SkLosers = π2+ π3P SkLosers

where P SkLosersis a dummy variable that equals one if short-seller k is classified as a P

S-short-seller considering only her deals on stocks from group Losers, and reti,k is the short-selling

return (gross, net, and risk-adjusted) of deal i closed by short-seller k on stocks that are not in the group Losers. Both regressions are estimated separately for institutions and individuals.

[Table 7 about here]

Table 7 present the results. Since the regressions are estimated using only stocks which presented a positive return over the full sample, we find that on average all short-sellers lose on these stocks. However, consistent with the existence of performance persistence for both P S-institutions and P S-individuals, these investors perform on average better (lose

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less) than the others. According to Panel A, institutions that are classified as P S-short-sellers within stocks in group Losers have on other stocks: expected gross return per deal of -0.761% (0.211% - 0.972%) v.s. -0.972% of institutions who are not classified as P S-short-sellers; median gross return per deal of -0.422% v.s. -0.556%; expected net return per deal of -0.917% v.s. -1.098%; median net return per deal of -0.525% v.s. -0.634%; expected risk-adjusted return per deal of 0.398% v.s. 0.048%; and median risk-adjusted return per deal of 0.431% v.s. 0.168%.

According to Panel B of Table 7, individuals that are classified as P S-short-sellers within stocks in group Losers have on other stocks: expected gross return per deal of -0.450% (0.606% - 1.052%) v.s. -1.052% of individuals who are not classified as P S-short-sellers; median gross return per deal of 0.000% v.s. -0.489%; expected net return per deal of -0.609% v.s. -1.192%; median net return per deal of -0.095% v.s. -0.590%; expected risk-adjusted return per deal of 0.477% v.s. 0.024%; and median risk-adjusted return per deal of 0.661% v.s. 0.213%.

According to Tables 6 and 7, short-sellers who outperform on large caps also outperform on other stocks, and short-sellers who outperform on stocks with negative full-sample return also outperform on stocks with positive full-sample return. These results show that there is performance persistence across these dimensions, reinforcing the existence of short-selling skill. We next take the cross-sectional out-of-sample exercise one step ahead. Since stocks can be randomly divided in an arbitrary number of ways, we perform 1,000 cross-sectional out-of-sample regressions. Our goal is to evaluate whether the evidence of performance persistence survives even in the least favorable sample splits.

3.2.3 Stock-dimension out-of-sample: 1,000 sample splits

We run 1,000 cross-sectional out-of-sample exercises to check performance persistence. Each out-of-sample exercise is based on the construction of two groups of stocks randomly selected, groups A and B. To assign stocks to either group, we first divide all stocks in our sample

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into four quantiles according to their total shorting volume during the full sample period. We then randomly assign half of the stocks in each quantile to group A and the other half to group B. By doing so, we end up with two random groups of stocks with similar shorting volume. Using only deals on stocks from group B, we estimate

E reti,k|P SAk = π0+ π1P SkA

M ed reti,k|P SkA = π2+ π3P SkA

where P SA

k is a dummy variable that equals one if short-seller k is a P S-short-seller

consid-ering only her deals on stocks from group A, and reti,k is the short-selling return (gross, net,

and risk-adjusted) of deal i closed by short-seller k. Regressions are estimated separately for institutions and individuals.

Figures 4, 5, and 6 present the histograms of the 1,000 estimates of π1 (the

out-of-sample superior mean performance of P S-short-sellers) and π3 (the out-of-sample superior

median performance of P S-short-sellers), with respect to gross, net, and risk-adjusted re-turns. Clearly, the P S-short-sellers performance is persistent for both institutions and in-dividuals. In virtually all of the 1,000 out-of-sample exercises, investors who are classified as P S-short-sellers in half of the stocks have superior performance in the other half of the stocks.

[Figures 4, 5, and 6 about here]

Table 8 tabulates the 1,000 estimates of π1 and π3. Panel A refers to the gross return

measure. Considering institutions, the average across the 1,000 estimates of π1 is 0.44%;

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1,000 estimates of π1 is positive (0.14%). The average of π3 is 0.33%; the median of π3 is

0.32%; and even the 5th percentile of π3 is positive (0.15%). Considering individuals, the

average of π1 is 0.91%; the median of π1 is also 0.91%; and even the 5th percentile of π1 is

positive (0.71%). The average of π3 is 0.76%; the median of π3 is also 0.76%; and even the

5th percentile of π3 is positive (0.62%).

[Table 8 about here]

Panel B of Table 8 refers to the net return measure. Considering institutions, the average

across the 1,000 estimates of π1is 0.50%; the median across the 1,000 estimates of π1is 0.49%;

and even the 5th percentile across the 1,000 estimates of π1 is positive (0.12%). The average

of π3 is 0.39%; the median of π3 is 0.38%; and even the 5th percentile of π3 is positive

(0.18%). Considering individuals, the average of π1 is 0.92%; the median of π1 is also 0.92%;

and even the 5th percentile of π1 is positive (0.71%). The average of π3 is 0.77%; the median

of π3 is also 0.77%; and even the 5th percentile of π3 is positive (0.62%).

Panel C of Table 8 refers to the risk-adjusted return measure. Considering institutions,

the average across the 1,000 estimates of π1 is 0.31%; the median across the 1,000 estimates

of π1 is also 0.31%; and even the 5th percentile across the 1,000 estimates of π1 is positive

(0.05%). The average of π3 is 0.26%; the median of π3 is 0.25%; and even the 5th percentile

of π3 is positive (0.12%). Considering individuals, the average of π1 is 0.62%; the median of

π1 is also 0.62%; and even the 5th percentile of π1 is positive (0.47%). The average of π3 is

0.52%; the median of π3 is also 0.52%; and even the 5th percentile of π3 is positive (0.41%).

In all three panels of Table 8, the 5th percentiles across the 1,000 estimates of π1 and

π3 are positive. This is remarkable. Even even in the less favorable random splits of our

sample, both P S-institutions and P S-individuals continue to outperform other investors out-of-sample.

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Aggregate predictability

Because of the well-documented predictability power of aggregate shorting over future re-turns, short-sellers are often collectively regarded as sophisticated investors with superior information (for instance, Boehmer, Jones, and Zhang, 2008, Diether, Lee, and Werner, 2009, Engelberg, Reed, and Ringgenberg, 2012, and Rapach, Ringgenberg, and Zhou, 2016). Based on this literature, an alternative way to present the evidence of performance persis-tence is by verifying whether the out-of-sample predictability power of aggregate shorting comes from P S-short-sellers.

To test this, we regress the 20-day ahead return of stock s on day t (rets,t+1→t+20) on

its number of shorted shares divided by its number of traded shares on day t (relsss,t).

We compute relss using deals from all short-sellers (relssall), using deals only from P

S-short-sellers (relssP S), and using deals only from other short-sellers (relssothers). Since we

are interested in out-of-sample performance of aggregate shorting, we first define P S-short-sellers using only deals on stocks from group A, and then run the out-of-sample predictability regressions using deals on stocks from group B. That is, for each one of the 1,000 samples randomly created we run the following panel regressions

rets,t+1→t+20 = β0+ βallrelssalls,t + s,t

rets,t+1→t+20 = β1+ βP SrelssP Ss,t + βothersrelssotherss,t + ηs,t

Figure 7 presents the results. The first histogram presents the 1,000 estimates of βall.

Most of the estimated coefficients are negative (895), confirming the well-documented evi-dence of aggregate shorting predicting lower future returns. The second and third histograms reveal that the predictability of aggregate shorting comes from deals by P S-short-sellers.

From a total of 1,000 regressions, βP S estimates are negative in 993 of them. In contrast, in

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[Figure 7 about here]

3.3

Yes, there is short-selling skill

In Section 3.1 we define three conditions for a short-seller to be classified as potentially skilled: she must have placed at least ten distinct short-selling deals, she must present sta-tistically positive average risk-adjusted return across her deals, and she must present positive monetary profit. We then show that P S-short-sellers, beside presenting good performance, also display higher shorting activity if compared to others in terms of number and size of deals, and number of stocks traded. Additionally, in Section 3.2 we perform time- and stock-dimension out-of-sample exercises and confirm that the good performance of P S-short-sellers is persistent out-of-sample. Taken together, these findings support the existence of shorting skill in the stock market. In the next section, we examine the trading behavior of P S-short-sellers. We present three empirical exercises, two related to the opening of their short positions and one related to the covering.

4

A closer look at P S-short-sellers trading activity

In this section we take a closer look at P S-short-sellers trading activity. In the first analysis, we decompose the P S-short-sellers’ total profit. A well-documented important source of short-sellers superior performance is their ability to anticipate firm-specific news. Christophe, Ferri, and Angel (2004) show that aggregate short-selling increases few days prior to negative earnings announcements. Engelberg, Reed, and Ringgenberg (2012) find that aggregate short-selling is particularly strong around days when firm-specific news is disclosed. The economic importance of such events to short-sellers’ realized profit is an open empirical

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question which can be addressed with our detailed data set. By how much does the realized profit of P S-short-sellers depend on the anticipation of firm-specific events? Since we observe both the initial and terminal dates of each loan deal, we can determine whether a firm-specific event did occur during the deal life span. From that, we can directly analyze the importance of firm-specific news to the realized profit of P S-short-sellers.

In the second analysis, we relate P S-short-sellers trading activity with past movements of stock prices. If informed short-sellers sell short following short-term stock price increases (thus acting as contrarian investors), they would contribute to the price discovery process by avoiding short-term price overshooting. On the other hand, if informed short-sellers sell short following short-term stock price falls (thus acting as short-term momentum investors), they would contribute to the price discovery process by accelerating the incorporation of negative information into stock prices.

In the third analysis, we study the covering of a short position. One of the most robust features of unsophisticated investors behavior is the so-called disposition effect, i.e., the tendency of riding losses and realizing gains (Barberis and Xiong, 2009). Accordingly, we expect P S-sellers to be less susceptible to the disposition effect than the other short-sellers. We test this by studying the decision of short-sellers to anticipate the covering of a shorting deal.

4.1

Decomposing P S-short-sellers profit

By how much does the realized profit of P S-short-sellers depend on the anticipation of firm-specific events? To answer this question, we focus on two types events: (i) negative earnings

announcements and (ii) negative material facts announced by firms16 (e.g. other corporate

16According to Brazilian regulation, important corporate news announcements must the disclosed

imme-diately by the firm (usually referred to as “material facts”), and any company insider endowed with this information is prohibited to disclose it privately or to trade upon it. Because of their nature – largely unan-ticipated and containing important information about the firm not yet impounded into prices –, material facts are important piece of news that affects prices significantly. Examples of material facts include proposal of mergers, changes of CEOs, and announcements of secondary public offering of shares.

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news announcements not directly related to earnings announcements).17 These types of

events differ from each other in some important aspects; it follows that anticipating them requires different skills. Earnings announcements occur periodically and are scheduled; their content is known in advance only by company insiders but can be potentially predicted using public information. In contrast, material facts occur sporadically, are not scheduled, and in principle should be unpredictable for company outsiders.

We calculate the share of short-sellers total profit that can be attributed to each event. To do so, we first compute the profit of each short-selling deal. We then determine whether

an event occurred during the life span of each deal.18 Each short-selling deal can fall in one

of the following four groups: i) disclosure of one or more negative earnings have occurred during the deal, ii) disclosure of one or more negative material facts have occurred, iii) disclosures of both types of events have occurred, and iv) no disclosures have occurred. Finally, we aggregate profits within each group to calculate the share of short-sellers total profit attributed to each event.

Figure 8 shows the share of short-sellers total profit attributed to each event. The chart on the left shows the shares for P S-institutions and the chart on the right for P S-individuals. For P S-institutions, we find that 19.9% of their total shorting profit (their total profit in the 3-year period was US$ 2.2 billion) came from deals during which a negative earning an-nouncement occurred, 17.1% from deals during which a negative material fact anan-nouncement occurred, and 3.2% from deals during which both events occurred. For P S-individuals, we find that 12.8% of their total shorting profit (their total profit in the 3-year period was US$ 50 million) came from deals during which a negative earning announcement occurred, 6.9% from deals during which a negative material fact announcement occurred, and 3.4% from deals during which both events occurred.

17To classify these announcements as negative, we follow Engelberg, Reed, and Ringgenberg (2012) and

look at what happens with the stock price on the day the information is made public. We say that an announcement is negative if on the day they are disclosed the stock price declines by more than one (firm-specific) standard deviation.

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[Figure 8 about here]

Christophe, Ferri, and Angel (2004) and Engelberg, Reed, and Ringgenberg (2012) show that aggregate short-selling increases prior to negative firm-specific events. Consistent with these results, we find that a significant portion of the short-sellers profit can be indeed at-tributed to negative earnings announcements and negative material fact announcements. However, it is important to emphasize that the greater portion of short-sellers profit is not dependent on the anticipation of these two types of firm-specific events (for institutions, 59.8%; for individuals, 76.9%). In particular, if total realized profit were heavily dependent on negative material fact announcements (which are not scheduled, and should be unpre-dictable for company outsiders), the practice of insider trading could potentially be the most important source of short-sellers profit as opposed to genuine shorting skill.

4.2

Do P S-short-sellers follow short-term contrarian or

momen-tum strategies?

To answer this, we run stock-day panel regressions of the number of investors selling short

stock s on day t (Ns,t) on the past performance of stock prices. We measure stock s past

performance in two different ways: (i) its 5-day past return, rets,t−5→t−1; and (ii) dummy

variables indicating the quintile stock s belongs to on day t with respect to rets,t−5→t−1.

Be-cause the number of investors can vary across stocks for other reasons than past performance, such as trading volume, number of shares outstanding, and lending market conditions, we include in all regressions stocks fixed-effects.

The results presented in Table 9 show that P S-short-sellers follow short-term momentum strategies. In contrast, other short-sellers follow short-term contrarian strategies. Columns (1) and (2) show that P S-institutions step up on days and on stocks that have experienced

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recent price falls. In contrast, Column (4) shows that other institutions tend to short stocks

that are in the top two quintiles of rets,t−5→t−1. A similar pattern arises for individuals.

Column (5) shows that P S-individuals tend to short stocks that have experienced recent price falls. In contrast, Column (7) indicates that other individuals tend to trade in stocks after recent price increases and Column (8) shows that they avoid stocks in the lower quintiles

of rets,t−5→t−1 and that they prefer stocks in the top quintiles of rets,t−5→t−1.

[Table 9 about here]

In a market with momentum stocks, a short-seller that follows short-term momentum strategies is likely to profit. This makes the in-sample result that P S-short-sellers follow short-term momentum strategies less interesting. To evaluate whether P S-short-sellers are intrinsically short-term momentum traders, we run regressions with the same 1,000 cross-sectional sample splits of Section 3.2. As before, each out-of-sample exercise is based on the construction of two groups of stocks randomly selected, groups A and B. To assign stocks to either group, we first divide all stocks in our sample into four quantiles according to their total shorting volume during the full sample period. We then randomly assign one half of the stocks in each quantile to group A and the other half to group B. By doing so, we end up with two random groups of stocks with similar shorting volume. Using only deals on stocks from group B, we then run stock-day panel regressions of the number of investors selling

short stock s on day t (Ns,t) on rets,t−5→t−1. Short-sellers are classified as P S-short-sellers

using stocks from group A.

Figure 9 shows four histograms of the 1,000 estimated coefficients of the regression. The top-left histogram refers to P S-institutions, the bottom-left to “other institutions”, the top-right to P S-individuals, and the bottom-right to “other individuals”. The out-of-sample results are consistent with the in-sample results for all groups, except for “other institutions”.

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The out-of-sample estimates strongly indicate that “other institutions” also follow short-term momentum strategies. Only “other individuals” are short-term contrarians: 701 out of the 1,000 estimates are positive, what suggests that these investors increase shorting activity

following higher rets,t−5→t−1.

[Figure 9 about here]

We conclude that both P S-institutions and P S-individuals sell short stocks that have

been experiencing recent price falls. This suggests that, as informed short-sellers, they

contribute to the price discovery process by accelerating the incorporation of negative

in-formation into stock prices, instead of by avoiding short-term price overshooting.19 This

is consistent with the evidence by Yan and Zhang (2009) who show that skilled

institu-tions—i.e. institutions whose trading activity predicts future returns—tend to trade at

short-term horizons and follow momentum strategies.

4.3

The disposition effect

The disposition effect refers to the tendency of investors to ride losses and realize gains. This asymmetric behavior across gains and losses is consistent with investors having loss-averse type of preferences (see for instance Tversky and Kahneman, 1991, and Barberis and Xiong, 2009). At least since Shefrin and Statman (1985), many papers have documented the dis-position effect in financial markets. Using proprietary data from a large discount brokerage house, Odean (1998) finds that individual investors are strongly affected by the disposition effect. Using an extensive data set from Finnish households, Grinblatt and Keloharju (2001) 19There is robust evidence that short-sellers contribute to price efficiency. Saffi and Sigurdsson (2011)

find that stocks with higher short-sale constraints, characterized by low lending supply, display lower price efficiency. Engelberg, Reed, and Ringgenberg (2013) find that stocks with more short-selling risk have less price efficiency. Bris, Goetzmann, and Zhu (2007), Boehmer and Wu (2013), and Purnanandam and Seyhun (2017) relate short-selling with price discovery.

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also document the disposition effect among individual investors. Using data from the Trea-sury Bond futures contract at the Chicago Board of Trade, Coval and Shumway (2005) finds that professional investors are also subject to the disposition effect and that are highly loss-averse. Locke and Mann (2005) show that futures traders tend to ride losses, although the authors argue this behavior does not affect their overall trading performance.

Regarding short-sellers, Beschwitz, Bastian, and Massa (2015) use a data set on equity lending on US stocks to show that short sellers are more likely to close a position when capital gains are higher, indicating the presence of disposition effect. Beschwitz, Bastian, and Massa (2015) do not differentiate skilled short-sellers from other short-sellers, however. We use our deal-by-deal data set to test the presence of the disposition effect among short-sellers. We run deal-level regressions where the dependent variable is a dummy that equals one if deal i was terminated by the short-seller earlier than the original expiration

date (T erminatei). In 99.2% of the loan contracts in our data set the borrower has the

option to return the stock to the lender earlier than the original expiration date in the loan contract; the early-return process is automatic and costless.

A short-seller who suffers from the disposition effect will be tempted to terminate earlier a deal if the stock price falls during the first few days after the short sale. Analogously, she will be tempted to hold the short position on if the stock price rises. Accordingly, to test

the existence of disposition effect among short-sellers, we regress T erminatei on the stock

return during the first five days after the opening of the deal (reti,5).20 That is, for each

group of short-sellers, we run the following deal-level regression:21

20To avoid polluting our analysis with deals that were originally schedule to last only few days, we include

in our regressions only deals that were originally set to expire in 10 days or more. Additionally, we also exclude deals with atypical long horizons (35 days or more) which are likely to be terminated earlier for other reasons. Deals with less than 10 days account for 1.6% of all deals, and deals with more than 35 days account for 8.2% of all deals.

21To estimate the coefficients in regression 1, we include only deals with the early return option to the

borrower. Additionally, to ensure that changes in the original duration of the deal are made by short-sellers, we also exclude deals that allow the lender to recall the stocks earlier. Of all 3,341,213 deals in our data set, 67.8% allow for both, short-sellers and lenders, to terminated the lending contract earlier, 31.4% allow for only short-sellers to return the stocks earlier, and 0.8% does not allow for neither short-sellers and lenders to terminate the lending contract earlier. There are no deals that allow only the lender to recall the stocks earlier.

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T erminatei = β0+ β1× reti,5+ i (1)

Table 10 reports the results. As expected, P S-short-sellers do not display disposition effect. After initially unfavorable returns, both P S-individual and P S-institutions actually tend to terminate the shorting deal earlier, contrary to what the disposition effect would induce. Columns (1) and (3) show that an increase in 10% in prices during the first five days of a deal increased by 0.1% the probability of an early termination for P S-institutions and by 2.6% for P S-individuals. In contrast, other short-sellers behave according to what is predicted by the disposition effect. Columns (2) and (4) show that an increase in 10% in prices during the first five days of a deal decreases by 0.8% the probability of an early termination for P S-institutions and by 1.6% for P S-individuals.

[Table 10 about here]

Once again, out-of-sample results are important. In a market with momentum stocks, the disposition effect can be directly related to poor performance. The existence of momentum implies that price increases (decreases) tend to be followed by a sustained period of price increases (decreases). If a short-seller initiates a short position in a momentum stock, the disposition effect would induce her to continue (terminate) a losing (winning) position and to realize larger losses (smaller gains).

Hence, to address concerns that P S-investors performance is mechanically related to the disposition effect, we reproduce our analysis out-of-sample. As in Section 3.2, we run the disposition effect regression in each one of the 1,000 samples randomly constructed. The histograms in Figure 10 present the empirical distribution of the estimated coefficients. As expected, individuals that are not potentially skilled are the most susceptible ones to the

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disposition effect. Out of the 1,000 estimates of β1, 940 are negative. In contrast, only

372 estimates of β1 are negative for P S-individuals. With respect to institutions, most of

the estimates are close to zero for both P S-institutions and other institutions, although a

slightly higher mass of negative β1 estimates can be observed for other institutions.

[Figure 10 about here]

5

Conclusion

We document the existence of short-selling skill among both institutions and individuals. This result contributes to the broad literature that searches for investment skills among market participants and, more directly, to the specific literature on short-selling. Very few is known at the short-seller level. Boehmer, Jones, and Zhang (2008) find that the average institution is more informed than the average individual. Jank and Smajlbegovic (2015) find that hedge funds outperform other short-sellers. Kelley and Tetlock (2017) documents that aggregate short-selling by individuals predicts lower returns. Wang, Lee, and Woo (2017) find that individuals who sell short more firms make higher profits and that their profitability is persistent over time.

We are the first to use market-wide investor-level data to provide comprehensive evidence on short-selling skill. We find that from a total of 4,107 institutions, 367 (8.9%) consistently profit from shorting. They are responsible for 31.5% of the total shorting volume and 26.7% of the total number of shorting deals. From a total of 35,338 individuals, 1,484 (4.2%) con-sistently profit from shorting. They are responsible for 0.3% of the total shorting volume and 2.5% of the total number of shorting deals. Importantly, these investors present robust out-of-sample performance persistence. To show this, we explore the fact that our performance analysis is at the deal-level and study persistence across stocks.

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We examine in more detail the trading activity of the short-sellers who consistently profit. We first show that the greater portion of their realized profit (for institutions, 59.8%; for individuals, 76.9%) is not dependent on the anticipation of negative earnings and material facts announcements. This is relevant. In particular, if total realized profit were heavily dependent on negative material fact announcements (which are not scheduled, and should be unpredictable for company outsiders), the practice of insider trading could potentially be the most important source of short-sellers profit as opposed to genuine shorting skill. We then show that skilled short-sellers follow short-term momentum strategies. This suggests that they contribute to the price discovery process by accelerating the incorporation of negative information into stock prices, instead of by avoiding short-term price overshooting. We finally show that, differently from the average short-seller, skilled short-sellers do not display the disposition effect.

The Brazilian stock market, such as other “modern but not so big” stock markets, offers a good laboratory for empirical studies in finance. From a computational perspective, the size of the Brazilian market facilitates market-wide empirical analyses at the deal-level. Impor-tantly, standard empirical facts for the equity lending market and short-selling documented for the US and Europe also hold in Brazil, ensuring external validity of our results. For instance, the short-selling share in total volume is similar (see Section 2), aggregate shorting also predicts future returns (see the aggregate predictability evidence in Section 3.2) and the loan market is also opaque and works in a similar way (Chague, De-Losso, Genaro, and Giovannetti, 2017).

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Imagem

Figure 1: Short-selling as a fraction of total trades

Figure 1:

Short-selling as a fraction of total trades p.38
Figure 2: Market portfolio

Figure 2:

Market portfolio p.39
Figure 3: Time evolution of some statistics by group of short-sellers

Figure 3:

Time evolution of some statistics by group of short-sellers p.40
Figure 4: Out-of-sample Performance Persistence (gross returns)

Figure 4:

Out-of-sample Performance Persistence (gross returns) p.41
Figure 5: Out-of-sample Performance Persistence (net returns)

Figure 5:

Out-of-sample Performance Persistence (net returns) p.42
Figure 6: Out-of-sample Performance Persistence (risk-adjusted returns)

Figure 6:

Out-of-sample Performance Persistence (risk-adjusted returns) p.43
Figure 7: Out-of-sample predictability regressions of aggregate shorting

Figure 7:

Out-of-sample predictability regressions of aggregate shorting p.44
Figure 9: Out-of-sample analysis of contrarian or momentum strategies

Figure 9:

Out-of-sample analysis of contrarian or momentum strategies p.46
Figure 10: Out-of-sample analysis of disposition effect

Figure 10:

Out-of-sample analysis of disposition effect p.47
Table 1: Descriptive statistics

Table 1:

Descriptive statistics p.48
Table 3: Top 10 P S-short-sellers

Table 3:

Top 10 P S-short-sellers p.50
Table 4: Activity level

Table 4:

Activity level p.51
Table 10: Disposition Effect

Table 10:

Disposition Effect p.57

Referências