The Short Squeeze: The 'Invisible' Cost of Short Sales

51 Pages Posted: 24 May 2016

See all articles by Wei Xu

Wei Xu

Peking University - HSBC School of Business

Yu Zheng

Queen Mary University of London

Date Written: May 23, 2016

Abstract

We study a risk-neutral trader’s decision to short an overpriced stock. A short squeeze occurs when a sudden increase in the price of a stock escalates due to the short sellers’ heightened demand for the stock to cover their existing short positions. We model how the potential squeeze limits the short position before the short-sale constraint becomes binding. Using the CRSP data, we empirically confirm the model prediction that the probability (cost) of a short squeeze is higher (lower) for stocks with greater liquidity. Short squeezes thus serve as an “invisible” cost of short sales, limiting the scope of arbitrage.

Keywords: Short selling; Short-sale constraint; Short squeeze; Limit to arbitrage

JEL Classification: G10, G12

Suggested Citation

Xu, Wei and Zheng, Yu, The Short Squeeze: The 'Invisible' Cost of Short Sales (May 23, 2016). Available at SSRN: https://ssrn.com/abstract=2783374 or http://dx.doi.org/10.2139/ssrn.2783374

Wei Xu (Contact Author)

Peking University - HSBC School of Business

University Town
Nanshan District
Shenzhen, Guang Dong 518055
China

Yu Zheng

Queen Mary University of London ( email )

Mile End Road
London, London E1 4NS
United Kingdom

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