We test the hypothesis that arbitrageurs amplify economic shocks in equity markets. The ability of speculators to hold short positions depends on asset values. Shorts are often reduced following good news about a stock. Therefore, the prices of highly shorted stocks are excessively sensitive to...

Theory suggests that, in the presence of local bias, the price of a stock should be decreasing in the ratio of the aggregate book value of firms in its region to the aggregate risk tolerance of investors in its region. Using data on U.S. states and Census regions, we find clear-cut support for...