International Finance Discussion Papers (IFDP)

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November 2015

Biased Shorts: Short sellers' Disposition Effect and Limits to Arbitrage

Bastian von Beschwitz and Massimo Massa

Abstract:

We investigate whether short sellers are subject to the disposition effect using a novel dataset that allows to identify the closing of short positions. Consistent with the disposition effect, short sellers are more likely to close a position the higher their capital gains. Furthermore, stocks with high short sale capital gains experience negative returns, suggesting that their disposition effect has an effect on stock prices. A trading strategy based on this finding achieves significant three-factor alphas. Overall, short sellers' behavioral biases limit their ability to arbitrage away the mispricing caused by the disposition effect of other market participants.

Keywords: Short selling, Disposition effect, Behavioral finance

DOI: http://dx.doi.org/10.17016/IFDP.2015.1147

PDF: Full Paper

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Last Update: June 19, 2020