Short Sales Constraints and Momentum in Stock Returns


  • Ashiq Ali,

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  • Mark A. Trombley

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    • *

      The authors are respectively from the University of Texas at Dallas and the University of Arizana. They gratefully acknowledge comments from Alexandre Baptista, Ed Dyl, Richard Frankel, Christi Gleason, Chris Lamoureux, Bill Maxwell, Bill Schwartz, Steven Thomas, Tzachi Zach and workshop participants at MIT, Temple University, Washington University, University of Arizona, University of Houston, University of Texas at Dallas and the 2005 JBFA Conference. They thank David Hait at OptionMetrics LLC for providing IvyDB option data, Thomson Financial for providing the I/B/E/S data, and Bart Danielsen and Chris Lamoureux for providing short interest and option data.

†Ashiq Ali, The University of Texas at Dallas, School of Management, SM41, 2601 N. Floyd Road, Richardson, TX 75083-0688, USA.


Abstract:  We show that stock characteristics identified by D’Avolio (2002) provide a reliable index of the mostly unobservable short sales constraints. Specifically, we find that this index is positively related to the level of short interest and to short selling costs implied by the disparity in prices in the options and stock markets, and is negatively related to future returns. Using this index, we show that the magnitude of momentum returns for the period 1984 to 2001 is positively related to short sales constraints, and loser stocks rather than winner stocks drive this result. We conclude that short sales constraints are important in preventing arbitrage of momentum in stock returns.