It has been shown that stocks with high short interest (the number of stocks sold short) have lower risk-adjusted returns compared to stocks with low short interest. Since short interest in stocks is publicly disclosed by exhanges, this return pattern constitutes a “short interest anomaly” because anyone can make money by short-selling stocks with high short interest and buying stocks with low short interest. What Limit to Arbitrage explanation can justify the persistence of this anomaly?

Question

It has been shown that stocks with high short interest (the number of stocks sold short) have lower  risk-adjusted  returns compared to stocks with low short interest. Since short interest in stocks is publicly disclosed by exhanges, this return pattern constitutes a “short interest anomaly” because anyone can make money by short-selling stocks with high short interest and buying stocks with low short interest. What Limit to Arbitrage explanation can justify the persistence of this anomaly?

Accepted Answer

If you account for the short-selling fees required to short sell stocks, you would not be able to generate profits on this anomaly

Answer

If you account for transaction costs, you would still be able to generate profits on this anomaly

Answer

Since this return gap between stocks with high and low short interest will never close, you cannot generate any profits on this anomaly

Answer

If you account for risks correctly when calculating risk-adjusted returns between the stocks with high and low short interest, there would be no difference in return, i.e., no profits for arbitrageurs

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It has been shown that stocks with high short interest (the number of stocks sol...

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