Predictive Power of Aggregate Short Interest

The short sale of a stock is motivated by financial profits an investor expects to gain from declining stock prices. Short interest, defined as the proportion of shares shorted to all outstanding shares for a given stock, represents the collective expectations of short sellers. While the variation in short interest at the firm level may be dominated by firm-specific expectations, the variation in an aggregate measure of short interest across a broad sample of stocks most likely reflects changing expectations of macroeconomic conditions. With this motivation, this paper examines the relationship between lagged aggregate short interest and cyclical changes in GDP using quarterly US data from 1973 to 2013. The results strongly suggest that lagged aggregate short interest is a statistically significant regressor in explaining cyclical changes in GDP at up to a 4 quarter lag. Moreover, these results do not change with the addition of control variables and are robust to the use of different filters to decompose the growth trend from the cyclical component of GDP.