Are Short Sellers Informed? Evidence from the 2007-2008 Subprime Mortgage Crisis

This paper examines the short selling activities around financial firms' announcements of asset write-downs during the 2007-2008 subprime mortgage crisis. We find that short sellers accumulate short positions prior to write-down announcements, and that stocks experience significantly negative returns around such announcements. These results suggest that the return predictability of short interests is due to short sellers' informational advantage. Furthermore, we show that short sellers increase their positions significantly in the announcement month and keep increasing their positions afterward, suggesting the feedback effect of the disclosed write-downs on financial firms' existing exposures. The valuable information contained in the short interest should encourage regulators to mandate stock exchanges disclose short selling activities more frequently.