The disposition effect on partially informed short sellers

Abstract

This paper examines how the disposition effect influences the trading behavior of partially informed short sellers. We measure short sellers' closing of short positions by the ratio of weekly closed short positions to the total number of shorted shares and analyze its relationship with the short-sale capital gains overhang. Using Taiwanese short sale data, we show that short sellers' closing of short positions is subjected to the disposition bias, while they are partially informed in the sense that a higher level of the short balance predicts a lower stock return. As a result, short sellers tend to close their short positions prematurely and fail to fully exploit the potential profits. Furthermore, the disposition effect is more pronounced in stocks with lower market capitalizations, lower liquidity, lower institutional ownership, and higher return volatility.