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The Cost of Shorting, Asymmetric Performance Reaction and the Price Response to Economic Shocks

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  • José Renato Haas Ornelas
  • Pablo José Campos de Carvalho

Abstract

We propose and test a model that combines of performance-based arbitrage, short-sale constraints and costly arbitrage. In the model, after an unexpected good earning surprise, short covering causes a price overshooting for highly shorted stocks. However, this price reaction is limited by short-selling costs. Also, while short arbitrageurs are forced to reduce their positions after a negative return, positive returns have no immediate effect on their managed funds, i.e., we propose an asymmetric performance-based arbitrage. The paper empirically tests model predictions using Brazilian short-selling data. Results support the overshooting phenomenon and provide evidence that the intensity of the overshooting is influenced by short-selling borrowing fee. Results also suggest that arbitrageurs behave asymmetrically to good and bad earning news.

Suggested Citation

  • José Renato Haas Ornelas & Pablo José Campos de Carvalho, 2015. "The Cost of Shorting, Asymmetric Performance Reaction and the Price Response to Economic Shocks," Working Papers Series 383, Central Bank of Brazil, Research Department.
    • Handle: RePEc:bcb:wpaper:383
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    References listed on IDEAS

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