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Informed trading before analyst downgrades: Evidence from short sellers

  • Christophe, Stephen E.
  • Ferri, Michael G.
  • Hsieh, Jim
Registered author(s):

    This paper studies short-selling prior to the release of analyst downgrades in a sample of 670 downgrades of Nasdaq stocks between 2000 and 2001. We find abnormal levels of short-selling in the three days before downgrades are publicly announced. Further, we show that this pre-announcement abnormal short-selling is significantly related to the subsequent share price reaction to the downgrade, and especially so for downgrades that prompt the most substantial price declines. Our findings are robust to various controls that might also affect short-selling such as pre-announcement momentum, three-day pre-announcement returns, and announcement-day share price. In addition, the results are independent of scheduled earnings announcements, analyst herding, and non-routine events near downgrades. Further evidence suggests that tipping is more consistent with the data than the prediction explanation which posits that short sellers successfully predict downgrades on the basis of public information about firms' financial health. Finally, we present evidence that downgraded stocks with high abnormal short-selling perform poorly over the subsequent six months by comparison with those with low abnormal short-selling. Overall, our results support the hypothesis that short sellers are informed traders and exploit profitable opportunities provided by downgrade announcements.

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    Article provided by Elsevier in its journal Journal of Financial Economics.

    Volume (Year): 95 (2010)
    Issue (Month): 1 (January)
    Pages: 85-106

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    Handle: RePEc:eee:jfinec:v:95:y:2010:i:1:p:85-106
    Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505576

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    1. Karl B. Diether & Kuan-Hui Lee & Ingrid M. Werner, 2009. "Short-Sale Strategies and Return Predictability," Review of Financial Studies, Society for Financial Studies, vol. 22(2), pages 575-607, February.
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    12. Hemang Desai & K. Ramesh & S. Ramu Thiagarajan & Bala V. Balachandran, 2002. "An Investigation of the Informational Role of Short Interest in the Nasdaq Market," Journal of Finance, American Finance Association, vol. 57(5), pages 2263-2287, October.
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    15. Mark T. Bradshaw, 2002. "GAAP versus The Street: An Empirical Assessment of Two Alternative Definitions of Earnings," Journal of Accounting Research, Wiley Blackwell, vol. 40(1), pages 41-66, 03.
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