Days to Cover and Stock Returns
Princeton University - Department of Economics; National Bureau of Economic Research (NBER)
Hong Kong University of Science and Technology
Hong Kong University of Science and Technology
Columbia University; Princeton University - Department of Economics; National Bureau of Economic Research (NBER)
Quantitative Investment Strategies, Goldman Sachs Asset Management
December 2015
Abstract:
A crowded trade problem emerges when speculators' positions are large relative to the liquidity of the asset, thereby making exit difficult. We study this problem, which has been a point of concern in the Dodd Frank Financial Reforms regarding systemic risk, through the lens of short-selling. We show in a simple model that days to cover (DTC), the ratio of short interest to trading volume, measures the costliness of exiting crowded trades. We find that arbitrageurs are worried about the crowding problem as short-sellers avoid illiquid stocks and require a signi ficant premium to enter into such positions. A strategy shorting high DTC stocks and buying low DTC stocks generates a 1.2% monthly return. We show that there is a comparably large days-to-cover eff ect on the long positions of levered hedge funds.
Number of Pages in PDF File: 59
Keywords: Days to Cover, Crowded Trades, Stock Returns
JEL Classification: G12, G14
