Short of capital : Stock Market Implications of Short Sellers’ Losses

We show that short sellers are constrained by their losses. Using unique data on the mark-to-market profits of short sellers of U.S. stocks, we document an asymmetric response of short selling to gains versus losses. Short selling substantially falls following large losses but does not respond to gains. Consistent with recent theory linking funding constraints to trading activity, short selling is more affected by losses among stocks subject to higher margin requirements. The well-documented predictive power of short interest for future returns falls with the fraction of short positions experiencing losses, indicating that loss-making short selling is less informed. We conclude that even though short selling is affected by funding constraints, limits to arbitrage are mitigated as the constraints are more binding for its most uninformed component