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

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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.

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  • Massimo Massa & Bastian von Beschwitz, 2015. "Biased Shorts: Short sellers’ Disposition Effect and Limits to Arbitrage," International Finance Discussion Papers 1147, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgif:1147
    DOI: 10.17016/IFDP.2015.1147
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