Should Investors Follow the Prophets or the Bears? Evidence on the Use of Public Information by Analysts and Short Sellers

Author:

Drake Michael S.1,Rees Lynn2,Swanson Edward P.2

Affiliation:

1. The Ohio State University

2. Texas A&M University

Abstract

ABSTRACT: We investigate whether short sellers and analysts differ in their use of information that is predictive of future returns. We find that short interest is significantly associated in the expected direction with all 11 variables examined. In contrast, analysts tend to positively recommend stocks with high growth, high accruals, and low book-to-market ratios, despite these variables having a negative association with future returns. We then investigate the profitability of using short interest in trading. We find abnormal returns (1.11 percent per month) from a zero-investment strategy that (1) shorts firms with highly favorable analyst recommendations (buy signal) but high short interest (sell signal), and (2) buys firms with highly unfavorable analyst recommendations (sell signal) but low short interest (buy signal). Short interest, therefore, appears to capture predictive information that can be used by investors in trading against analysts’ recommendations to increase returns.

Publisher

American Accounting Association

Subject

Economics and Econometrics,Finance,Accounting

Reference46 articles.

1. An empirical investigation of short interest;Asquith,1995

2. Information content of equity analyst reports;Asquith;Journal of Financial Economics,2005

3. Short interest, institutional ownership, and stock returns;Asquith;Journal of Financial Economics,2005

4. Can investors profit from the prophets? Security analyst recommendations and stock returns;Barber;The Journal of Finance,2001

5. Comparing the stock recommendation performance of investment banks and independent research firms;Barber;Journal of Financial Economics,2007

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