Why do firm fundamentals predict returns: Evidence from short selling activity

Mazouz, Khelifa ORCID: https://orcid.org/0000-0001-6711-1715 and Wu, Yuliang 2022. Why do firm fundamentals predict returns: Evidence from short selling activity. International Review of Financial Analysis 79 , 101974. 10.1016/j.irfa.2021.101974

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Abstract

This study uses short selling activity to test whether the relation between fundamentals and future returns is due to rational pricing or mispricing. We find that short sellers target firms with fundamental performance below market expectations. We also show that short selling activity reduces the return predictability of fundamentals by speeding up the price adjustments to negative fundamental signals. To further investigate whether the returns earned by short sellers reflect rational risk premia or mispricing, we exploit a natural experiment, namely Regulation of SHO, which creates exogenous shocks to short selling by temporarily relaxing short-sale constraints. Evidence from the experiment confirms that the superior returns to short sellers result from exploiting overpricing. Overall, our study suggests that the return predictability of fundamentals reflects mispricing rather than rational risk premia.

Item Type:	Article
Date Type:	Publication
Status:	Published
Schools:	Business (Including Economics)
Publisher:	Elsevier
ISSN:	1057-5219
Date of First Compliant Deposit:	2 December 2021
Date of Acceptance:	5 November 2021
Last Modified:	14 Nov 2024 21:00
URI:	https://orca.cardiff.ac.uk/id/eprint/145781

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