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Short Covering
2023-03-09 09:57:59
We construct novel measures of net and gross short covering to examine when short sellers exit positions. We find that idiosyncratic limits to arbitrage, such as adverse stock price movements, volatility, and equity lending fees are associated with significantly higher position closures and lower price efficiency. Moreover, these position closures predict future return movements in the wrong direction, suggesting short sellers are induced to exit too early. In contrast, we find little evidence that aggregate limits to arbitrage including VIX, funding liquidity, and market volatility affect short covering. Contrary to theory, the results show that firm-level limits to arbitrage are important determinants of trading behavior.
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