Short Selling Efficiency

We examine the effects of short selling efficiency (SSE) on the aggregate stock market, with SSE measured by the slope coefficient of a cross-sectional regression of abnormal short interest on the overpricing measure. We find that SSE strongly and negatively predicts the equity risk premium, suggesting that large overpricing exists when short selling is executed in the right stocks. The predictive power of SSE is at least as strong as aggregate short interest and appears stronger when the level of short interest is high. Moreover, low SSE signals more efficient market and the CAPM performs well in the subsequent month.