Not logged in.
Quick Search - Contribution
Contribution Details
| Type | Bachelor's Thesis |
| Scope | Discipline-based scholarship |
| Title | Under which circumstances does the investor benefit from short selling? |
| Organization Unit | |
| Authors |
|
| Supervisors |
|
| Language |
|
| Institution | University of Zurich |
| Faculty | Faculty of Economics, Business Administration and Information Technology |
| Date | 2014 |
| Zusammenfassung | In this thesis short selling with respect to individual investors is investigated. Where individual investors are not institutional investors but rather small private individuals who wish to make some investments in a small manner. It is assumed that these private individuals do not make use of high frequency trading. The very basic intuition for short selling to be profitable is that a repurchased asset has to cost less than what the investor received when he initially borrowed and sold it. Besides this intuition there are several factors that can influence the likelihood of the profitability of a short sale to be executed as well as if a short sale is profitable over all. So far there is very little research done to investigate short selling on the individual level. This leads to author of this thesis to investigate under which circumstances an individual investor does benefit from short selling. In order to find such circumstances academic literature were reviewed and practitioners’ arguments were taken into account. Introducing into short selling, the mechanism of a short sale is depicted from which some risks of short selling might already occur. There are several motives for investors to short sell, such as if stock prices deviate from fundamental value or if arbitrage opportunities are present. Also, short selling can arise from an investor’s expectation of decreasing asset prices where in such a case short selling is purely motivated by speculative reasons. In short selling there are several risks that are encountered by the investor that arise either from the lending process or the short sale itself. Predominant risks are the risk of a short-squeeze and a theoretical infinite loss occurring from the short sale. By considering the complexity and numerous risks of short selling it can already be mentioned that there might be better strategies to profit from decreasing prices. In order to compare short selling to alternative strategies, futures, options, and ETFs are discussed. By reviewing short selling strategies from academic literature it can be seen that many strategies trade on deviations from fundamental values. Further strategies excerpted include trading on valuable information such as insider information. If short interest of specific assets increases due to investors exploiting profitable short selling opportunities, short interest can be a strong indicator for a circumstance that enables the investor to profit from short selling. Where trading solely on short-selling activity is also one of the strategies in literature. Also regulatory constraints on short selling that are imposed in an effort to return to the orderly function of securities markets are taken into account. Controversially, these regulations might have contributed to the decrease of stock prices. If regulations are introduced, and the possibility of regulations being introduced in the future, this might inhibit short selling in favour of alternative strategies to profit from decreasing prices. In a further section two models, which take short selling into account, are analysed. The first model takes the reliance on collateral to secure loans, the particular collateral requirements, and the scarcity of collateral into account where this is relevant to the prerequisite lending process of a short sale. By analysing this model it can be stated that collateral requirements should be such that they do not inhibit lending, limit borrowing, and distort consumption decisions. The second model analysed allows to derive beneficial circumstances arising from asset prices and types of beliefs of traders. The model analyses the quantitative consequences of imposing short-selling constraints for asset-pricing dynamics in a model with heterogeneous beliefs. Traders have to decide every period how much to buy or sell of an inelastically supplied risky asset and base their decision on a specific behavioural prediction strategy. As diversity of expectations among investors leads to overpricing, profitable short-selling opportunities occur when prices slope back to fundamental value. If asset prices initially increase, expectations of chartists are confirmed. At some point the capital gain cannot compensate for the lower dividend yield, leading to decreasing returns that eventually becomes negative. This can be seen as a turning point where the fraction of fundamentalists drastically increases. Following this, prices decrease back to fundamental value where these circumstances can be profitable for individual investors following a short selling strategy. Taking practitioners’ arguments into account one can state that many big and successful investors tend to avoid short selling. This is justified by arguing that setting up a short sale is difficult and by pointing out that there is theoretically unlimited risk compared to limited potential return. There are well-known short sellers, which state that it takes the right mind-set being able to focus on short selling. Many big and successful investors are value investors, concluding they rarely take short selling into account as an investment opportunity. The fact that many investors are value orientated might open a market niche for short sellers. Short selling is also subject to many market manipulations. It seems that big investors have the power to influence stock prices by only making use of the right words. By closely following such happenings, an individual investor might be able to profit from short selling during a dramatic fall of a stock price induced by manipulative intentions. Concluding the results obtained, circumstances under which an individual investor might profit from short selling such as if prices deviate from fundamental value, an investor is in possession of private information, and if there is high short interest for some security were found. If it is further assumed that investors exploit profitable short selling opportunities, there will be an increase in short interest for a specific security that can be seen as distilled indicator for individual investors to short sell. Considering future work based on this thesis, the results obtained can be tested empirically using past data of stock prices and data on short interest. |
| Export |
BibTeX
|