Sophisticated investors with access to private information about impending bad news in a company can trade profitably by way of short selling. It has long been argued that short sellers represent a sophisticated subset of investors given the relative costs of short selling, and prior research suggests that short sellers are, on average, able to predict lower future performance.
The recent availability of trading data for a large set of firms has allowed us to test some of these assertions.
Using a variety of corporate announcements — such as earnings announcements and management forecast announcements — we find no evidence that short sale transactions rise in size or frequency before bad news announcements.
Further, examining the link between daily stock returns and daily changes in short sale transactions, we find no evidence that increases in short sale transactions precede stock price declines. In fact, we find that short sale transactions increase at the announcement of significant news events, irrespective of whether the news is good or bad.