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Business Cycle Variation in Short Selling Strategies: Picking During Expansions and Timing During Recessions

Published online by Cambridge University Press:  05 May 2022

Peter N. Dixon
United States Securities and Exchange Commission
Eric K. Kelley*
University of Tennessee Haslam School of Business
* (corresponding author)


We present evidence that short sellers alternate between stock picking during expansions and market timing during recessions. First, firm-level short interest is a much stronger negative predictor of the cross-section of stock returns during expansions than it is during recessions. High short interest also only predicts negative future earnings announcement returns during expansions. We attribute these findings to short sellers’ emphasis on collecting firm-specific signals. Second, short sellers appear to make factor bets more so during recessions than during expansions. These bets tend to pay off as we observe a strong negative relation between the betas of highly shorted stocks and future stock market returns, a result that disappears during expansions. Together, these findings are consistent with theories of information acquisition under attention constraints, endogenous information production, as well as theories of time variation in aggregate overconfidence amongst traders.

Research Article
© The Author(s), 2022. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

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We thank Jennifer Conrad (the editor), Andy Puckett, Matthew Ringgenberg (the referee), and seminar participants at University of Mississippi and University of Tennessee for comments, and Tyler Henry for help with the short interest data. Kelley acknowledges support from the Home Federal Bank Scholar Award. The Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This article expresses the author’s views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the staff. All errors are our own.


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