Biased Shorts: Short sellers’ Disposition Effect and Limits to Arbitrage

Massa, Massimo; von Beschwitz, Bastian

doi:10.17016/IFDP.2015.1147

Working Paper

Biased Shorts: Short sellers’ Disposition Effect and Limits to Arbitrage

Abstract: We investigate whether short sellers are subject to the disposition effect using a novel dataset that allows to identify the closing of short positions. Consistent with the disposition effect, short sellers are more likely to close a position the higher their capital gains. Furthermore, stocks with high short sale capital gains experience negative returns, suggesting that their disposition effect has an effect on stock prices. A trading strategy based on this finding achieves significant three-factor alphas. Overall, short sellers? behavioral biases limit their ability to arbitrage away the mispricing caused by the disposition effect of other market participants.

Keywords: Short selling; Disposition effect; Behavioral finance;

https://doi.org/10.17016/IFDP.2015.1147