The Information Content of Short Interest: A Natural Experiment

Tom Arnold, Alexander W. Butler, Timothy Falcon Crack and Yan Zhang
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Tom Arnold: E. Claiborne Robins School of Business, University of Richmond
Timothy Falcon Crack: University of Otago
Yan Zhang: State University of New York, Binghamton

Journal of Business, 2005, vol. 78, issue 4, pages 1307-1336

Abstract: An increase in the cost of selling short should increase the bearish information content of short interest announcements by driving relatively uninformed short sellers out of the market. We extend the Diamond and Verrecchia (1987) model to include short selling against the box and test the extended model using a natural experiment based around the Taxpayer Relief Act of 1997 (TRA97). TRA97 made short selling more costly for those shorting against the box. Consistent with the implications of our extended model, this increase in short-selling costs strengthens the negative relationship between short interest and subsequent stock price performance post TRA97.

Date: 2005

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