Momentum and reversal: The role of short selling

• Main Authors: ZHU, Zhaobo, DUAN, Xinrui, SUN, Licheng, Tu, Jun
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2019
• Subjects: Momentum; Reversal; Short selling; Short-sale constraints; Corporate Finance; Finance and Financial Management; Portfolio and Security Analysis
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/6667; https://ink.library.smu.edu.sg/context/lkcsb_research/article/7670/viewcontent/Momentum_Reversal_av.pdf
• Institution: Singapore Management University

This paper investigates the relation between short selling and momentum. We document that a consistent momentum strategy that buys lightly shorted winners and sells heavily shorted losers exhibits strong short-term momentum and no long-term reversal. In contrast, an inconsistent momentum strategy that buys heavily shorted winners and sells lightly shorted losers experiences weak short-term momentum and persistent long-term reversal. Our results are robust after controlling for firm characteristics, proxy for short-sale constraints, and investor sentiment, as well as an exogenous shock (the Taxpayer Relief Act of 1997). These findings present a new challenge to existing theories of momentum that rely solely on investor underreaction and overreaction.