The past year's wild market swings also have brought home the importance of the relationship between volatility and aggressive shorting of stocks.
Lauren Cohen, assistant professor of finance at the Harvard Business School, Boston, studied data for stock loans to institutional investors that shed new light on how shorting reveals investor sentiment about a stock's future performance. His paper, Supply and Demand Shifts in the Shorting Market, was published in the Journal of Finance's October 2007 issue.
The shorting demand is important because it tells us something about what arbitrageurs may know about what's going to happen to future prices of stocks, Mr. Cohen said in an interview. He co-authored the research paper with Karl Diether, assistant professor of finance at Ohio State University, Columbus, and Christopher Malloy, assistant professor at Harvard Business School.
An increase in shorting demand leads to a negative return of 289 basis points in the following month, or 35% to 40% annualized. That's one of our big takeaways, Mr. Cohen added.
Mr. Cohen's research has been noted in the investment world.
We were aware of (Mr. Cohen's research) as a working paper before its publication. It's interesting and well-done, said Bruce Jacobs, a principal at Jacobs Levy Equity Management Inc., Florham Park, N.J., with $20 billion in assets under management including long-short strategies.Isabelle Clary