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.
Days to Cover, Crowded Trades, Stock Returns
Finance | Finance and Financial Management
HONG, Harrison G.; LI, Frank Weikai; NI, Sophie X.; SCHEINKMAN, Jose A.; and YAN, Philip.
Days to cover and stock returns. (2016). 1-61. Research Collection Lee Kong Chian School Of Business.
Available at: http://ink.library.smu.edu.sg/lkcsb_research/5323
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