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Short Sales Constraints and Momentum in Stock Returns

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  • Ashiq Ali
  • Mark A. Trombley

Abstract

We show that stock characteristics identified by D’Avolio (2002) provide a reliable index of the mostly unobservable short sales constraints. Specifically, we find that this index is positively related to the level of short interest and to short selling costs implied by the disparity in prices in the options and stock markets, and is negatively related to future returns. Using this index, we show that the magnitude of momentum returns for the period 1984 to 2001 is positively related to short sales constraints, and loser stocks rather than winner stocks drive this result. We conclude that short sales constraints are important in preventing arbitrage of momentum in stock returns.

Suggested Citation

  • Ashiq Ali & Mark A. Trombley, 2006. "Short Sales Constraints and Momentum in Stock Returns," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 33(3‐4), pages 587-615, April.
    • Handle: RePEc:bla:jbfnac:v:33:y:2006:i:3-4:p:587-615
    DOI: 10.1111/j.1468-5957.2006.00616.x
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    Cited by:

    1. David Hirshleifer & Siew Hong Teoh & Jeff Jiewei Yu, 2011. "Short Arbitrage, Return Asymmetry, and the Accrual Anomaly," The Review of Financial Studies, Society for Financial Studies, vol. 24(7), pages 2429-2461.
    2. Garcia-Feijoo, Luis & Jensen, Gerald R. & Jensen, Tyler K., 2018. "Momentum and funding conditions," Journal of Banking & Finance, Elsevier, vol. 88(C), pages 312-329.
    3. Mohamad, Azhar & Jaafar, Aziz & Hodgkinson, Lynn & Wells, Jo, 2013. "Short selling and stock returns: Evidence from the UK," The British Accounting Review, Elsevier, vol. 45(2), pages 125-137.
    4. Michael McKenzie & Ólan T. Henry, 2012. "The determinants of short selling: evidence from the Hong Kong equity market," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 52, pages 183-216, October.
    5. Yongqiang Chu & David Hirshleifer & Liang Ma, 2020. "The Causal Effect of Limits to Arbitrage on Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 75(5), pages 2631-2672, October.
    6. Liu, Ming-Yu & Chuang, Wen-I & Lo, Chien-Ling, 2021. "Options-implied information and the momentum cycle," Journal of Financial Markets, Elsevier, vol. 53(C).
    7. Xiafei Li & Chris Brooks & Joëlle Miffre, 2009. "Low-cost momentum strategies," Journal of Asset Management, Palgrave Macmillan, vol. 9(6), pages 366-379, February.
    8. Gang Hu & J. Ginger Meng & Mark E. Potter, 2008. "Opinion Divergence Among Professional Investment Managers," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 35(5‐6), pages 679-703, June.
    9. Chen, Hong-Yi & Yang, Sharon S., 2020. "Do Investors exaggerate corporate ESG information? Evidence of the ESG momentum effect in the Taiwanese market," Pacific-Basin Finance Journal, Elsevier, vol. 63(C).
    10. Ying Hao & Hsiang-Hui Chu & Kuan-Cheng Ko & Lin Lin, 2016. "Momentum Strategies and Investor Sentiment in the REIT Market," International Review of Finance, International Review of Finance Ltd., vol. 16(1), pages 41-71, March.
    11. Clark, Ephraim & Kassimatis, Konstantinos, 2014. "Exploiting stochastic dominance to generate abnormal stock returns," Journal of Financial Markets, Elsevier, vol. 20(C), pages 20-38.
    12. Jungshik Hur & Vivek Singh, 2016. "Reexamining momentum profits: Underreaction or overreaction to firm-specific information?," Review of Quantitative Finance and Accounting, Springer, vol. 46(2), pages 261-289, February.
    13. Eli Beracha & Hilla Skiba, 2011. "Momentum in Residential Real Estate," The Journal of Real Estate Finance and Economics, Springer, vol. 43(3), pages 299-320, October.
    14. Jungshik Hur & Mahesh Pritamani & Vivek Sharma, 2010. "Momentum and the Disposition Effect: The Role of Individual Investors," Financial Management, Financial Management Association International, vol. 39(3), pages 1155-1176, September.
    15. Badreddine, Sina & Galariotis, Emilios C. & Holmes, Phil, 2012. "The relevance of information and trading costs in explaining momentum profits: Evidence from optioned and non-optioned stocks," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 22(3), pages 589-608.
    16. Manuel Ammann & Marcel Moellenbeck & Markus M Schmid, 2011. "Feasible momentum strategies in the US stock market," Journal of Asset Management, Palgrave Macmillan, vol. 11(6), pages 362-374, February.
    17. Gao, Yang & Leung, Henry, 2017. "Impact of short selling restrictions on informed momentum trading: Australian evidence," Pacific-Basin Finance Journal, Elsevier, vol. 45(C), pages 103-115.
    18. Gil Aharoni & Tuan Q. Ho & Qi Zeng, 2012. "Testing the growth option theory: the profitability of enhanced momentum strategies in Australia," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 52(2), pages 267-290, June.
    19. Michael McKenzie & Olan T. Henry, 2007. "The Determinnts of Short Selling in the Hong Kong Equities Market," Department of Economics - Working Papers Series 1001, The University of Melbourne.
    20. Alexander Barinov, 2014. "Turnover: Liquidity or Uncertainty?," Management Science, INFORMS, vol. 60(10), pages 2478-2495, October.
    21. Steve Thomas, 2006. "Discussion of Short Sales Constraints and Momentum in Stock Returns," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 33(3‐4), pages 616-631, April.
    22. Hirshleifer, David & Teoh, Siew Hong & Yu, Jeff Jiewei, 2007. "Do short-sellers arbrtrage accrual-based return anomalies?," MPRA Paper 5510, University Library of Munich, Germany, revised 27 Oct 2007.
    23. Khasawneh, Maher & McMillan, David G. & Kambouroudis, Dimos, 2024. "Left-tail risk and UK stock return predictability: Underreaction, overreaction, and arbitrage difficulties," International Review of Financial Analysis, Elsevier, vol. 95(PA).

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