Should Investors Follow the Prophets or the Bears? Evidence on the Use of Public Information by Analysts and Short Sellers

We investigate whether short sellers and analysts differ in their use of information that is predictive of future returns. We find that short interest is significantly associated in the expected direction with all 11 variables examined. In contrast, analysts tend to positively recommend stocks with...

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Bibliographic Details
Published in:The Accounting review 2011-01, Vol.86 (1), p.101-130
Main Authors: Drake, Michael S., Rees, Lynn, Swanson, Edward P.
Format: Article
Language:English
Subjects:
Analysts
Analytical forecasting
Arbitrage
Coefficients
Earnings forecasting
Experts
Financial portfolios
Information
Investment returns
Investment strategies
Investors
Personal finance
Price momentum
Rates of return
Recommendations
Short sales
Statistical significance
Stock prices
Stock returns
Stock sales
Studies
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Summary:We investigate whether short sellers and analysts differ in their use of information that is predictive of future returns. We find that short interest is significantly associated in the expected direction with all 11 variables examined. In contrast, analysts tend to positively recommend stocks with high growth, high accruals, and low book-to-market ratios, despite these variables having a negative association with future returns. We then investigate the profitability of using short interest in trading. We find abnormal returns (1.11 percent per month) from a zero-investment strategy that (1) shorts firms with highly favorable analyst recommendations (buy signal) but high short interest (sell signal), and (2) buys firms with highly unfavorable analyst recommendations (sell signal) but low short interest (buy signal). Short interest, therefore, appears to capture predictive information that can be used by investors in trading against analysts' recommendations to increase returns.
ISSN:0001-4826
1558-7967
DOI:10.2308/accr.00000006