Short Interest Ratio and Equity Market Return : Causality and Impulse Response Functions

This study examines the causal link between short interest ratio and equity market return and their respective impulse response functions. Based on the analysis of monthly data from 1931M6 to 2012M12, the results reveal that there is a causal link between NYSE short interest ratio and the returns on the NYSE value-weighted and NYSE smallest-cap portfolios. At the aggregated level, the returns on the NYSE value-weighted and NYSE smallest-cap portfolios significantly jump in response to shock to NYSE short interest ratio suggesting that investors who are engaged in short-selling trade, on average, are not really informed. In addition, the NYSE short interest ratio drops significantly following shocks to the returns on the NYSE value-weight, NYSE equal-weighted, NYSE largest-cap and NYSE smallest-cap portfolios suggesting investors follow the momentum in the stock market and reduce their short-selling trade activity significantly