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Short Selling and Price Discovery in Corporate Bonds

Published online by Cambridge University Press:  03 December 2018

Terrence Hendershott ,
Roman Kozhan  and
Vikas Raman
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Abstract

We show short selling in corporate bonds forecasts future bond returns. Short selling predicts bond returns where private information is more likely, in high-yield bonds, particularly after Lehman Brothers’ collapse of 2008. Short selling predicts returns following both high and low past bond returns. This, together with short selling increasing following past buying order imbalances, suggests short sellers trade against price pressures as well as trade on information. Short selling predicts bond returns both in the individual bonds that are shorted and in other bonds by the same issuer. Past stock returns and short selling in stocks predict bond returns but do not eliminate bond short selling predicting bond returns. Bond short selling does not predict the issuer’s stock returns. These results show bond short sellers contribute to efficient bond prices and that short sellers’ information flows from stocks to bonds but not from bonds to stocks.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 55 , Issue 1 , February 2020 , pp. 77 - 115
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

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Footnotes

1

We thank an anonymous referee and Hendrik Bessembinder (the editor). We are grateful to Lauren Cohen, Harald Hau, Charles Jones, Adam Reed, Pedro Saffi, and Elvira Sojli, as well as participants at the 2018 Annual Meeting of the European Finance Association and several research seminars for providing helpful comments and suggestions. Hendershott provides expert witness services to a variety of clients. He gratefully acknowledges support from the Norwegian Finance Initiative.

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