Can short sellers inform bank supervision?

We investigate the timeliness and accuracy of supervisory information and short sellers’ signals to assess whether short sellers have the potential to inform bank supervision. We find that short interest in the bank’s equity increases prior to downgrades in supervisory ratings but does not decrease prior to upgrades in supervisory ratings. Our tests of the relative forecasting accuracy of short sellers’ signals and supervisory ratings indicate short sellers accurately assess the changes in both deteriorating and improving bank fundamentals but do not focus on the same fundamental variables as supervisors. Our results indicate that short sellers’ signals have the potential to complement the supervision in monitoring banks’ risk.