Shorting Demand and Predictability of Returns

Lauren Cohen, Karl B. Diether and Christopher J. Malloy

Volume 7, Number 1, First Quarter 2009

We examine the link between shorting and future returns in the equities market using a proprietary dataset of stock loan fees and quantities. We find that separating supply and demand shifts provides a richer view of the information contained in the securities lending market. Specifically, when separating into supply and demand shifts, we find that increases in shorting demand predict large negative abnormal returns next month (−2.98%), while changes in supply exhibit only modest predictive ability. The returns to a strategy exploiting the information in these demand shifts is large and significant even after: risk adjusting, taking into account the explicit costs of shorting, and taking into account additional transaction costs of the strategy. Collectively these results suggest that understanding more deeply the dynamics of the securities lending market can help us to make better predictions of future stock returns.