Short interest, stock returns and credit ratings

This paper investigates the role of credit risk in the relationship between short-selling activity and future stock returns. We find that the predictive power of short interest for future returns is concentrated in the worst-rated stocks. Low-grade stocks with the largest short interest decrease outperform those with the largest short interest increase by 1.09 percent in the following month. This return spread is robust to controls for cross-sectional effects and firm characteristics, and is much more pronounced during periods of high investor sentiment and low liquidity. Distressed firms with large short interest increases experience a worse performance subsequently.