KNOWLEDGE LINK  
Finance professor's research paper honored by leading journal

A study on the shorting market and stock prices, co-authored by a Fisher College of Business professor received a 2007 Smith Breeden Prize as a “Distinguished Paper” in “The Journal of Finance,” on January 5.

Karl B. Diether, an assistant professor in finance, co-authored the study, “Supply and Demand Shifts in the Shorting Market,” with Lauren Cohen and Christopher J. Molloy, both on the faculty at Harvard Business School. The article was published in the October 2007 edition of “The Journal of Finance.

The researchers’ paper examined the link between the shorting market and stock prices. The paper found that shorting demand is an important predictor of future stock returns. Diether and his colleagues were able to analyze signals in the short selling market through studying stock loan fees and the number of shares in the transactions.

“One of the things the paper had going for it is that we had a fairly unique data set. No one else had this data,” said Diether, who teaches Security Markets and Investments. “No one has ever looked at the joint role of stock loan fees and quantities.”

Since short selling happens behind the scenes among brokers, hedge funds and large institutional investment firms, access to data is relatively limited, Diether said. The researchers were able to get access to data for the study from a large institutional investor. The firm provided the scholars with access to individual contracts, which detailed the quantity of shares and the prices paid, including the stock loan fees.

“We found that when short sellers were willing to pay very high loan fees, but at the same time take really big positions, it was a very strong predictor of future performance for a stock,” Diether said. “It means they must know something or must have access to private information or they are better at accessing the importance of public information and news than other market participants.”

The researchers wrote in the abstract: “we show that our results are stronger in environments with less public information flow, suggesting that the shorting market is an important mechanism for private information revelation into prices.”

The entire study is available on Diether’s Web site, at fisher.osu.edu/~diether_1/papers/shifts.pdf.