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Do arbitrageurs amplify economic shocks?

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Listed:
  • Hong, Harrison
  • Kubik, Jeffrey D.
  • Fishman, Tal

Abstract

We test the hypothesis that arbitrageurs amplify economic shocks in equity markets. The ability of speculators to hold short positions depends on asset values. Shorts are often reduced following good news about a stock. Therefore, the prices of highly shorted stocks are excessively sensitive to shocks compared with stocks with little short interest. We confirm this hypothesis using several empirical strategies including two quasi-experiments. In particular, we establish that the price of highly shorted stocks overshoots after good earnings news due to short covering compared with other stocks.

Suggested Citation

  • Hong, Harrison & Kubik, Jeffrey D. & Fishman, Tal, 2012. "Do arbitrageurs amplify economic shocks?," Journal of Financial Economics, Elsevier, vol. 103(3), pages 454-470.
    • Handle: RePEc:eee:jfinec:v:103:y:2012:i:3:p:454-470
    DOI: 10.1016/j.jfineco.2011.10.007
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    More about this item

    Keywords

    Shorting; Short covering; Leverage; Destabilizing arbitrage;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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