AFBC-Days to Cover and Stock Returns

Weikai Li    Harrison Hong, Frank Weikai Li, Sophie Ni, Jose Scheinkman, Philip Yan
10 Nov 2016
Categories: Fundamental Analysis, Investment Management, Alternative Assets, Equity Investments, Behavioral Finance

Country or region: Asia Pacific (Overall)

Days to cover, short interest ratio divided by average daily share turnover, and not short interest ratio measures the rewards to entering crowded trades.

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A crowded trade emerges when speculators' positions are large relative to the asset's liquidity, making exit difficult. We study this problem of recent regulatory concern by focusing on short-selling. We show that days to cover (DTC), the ratio of short interest to trading volume, measures the costliness of exiting crowded trades. Crowding is an important concern as short-sellers avoid illiquid stocks, which we establish using an instrumental-variables strategy involving staggered stock market decimalization reforms. Arbitrageurs require a premium to enter into such trades as a strategy shorting high DTC stocks and buying low DTC stocks generates a 1.2% monthly return. A smaller days-to-cover effect also exists on the long positions of levered hedge funds.

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