We infer investors' expectations about future stock returns through a measure of short conviction that exploits net short positions disclosed at the investor-stock level for European stock markets. A strategy that sells high-conviction stocks and buys low-conviction stocks, named Best Short, generates a risk-adjusted excess return that is larger than 8% per annum and differs from the performance of traditional strategies based on aggregate short interest. Its profitability, moreover, cannot be explained by transaction costs, stock characteristics, frictions in the securities lending market, leverage constraints, and measures of price inefficiency.

The literature on short selling focuses mostly on open short positions, which are found to be informative for future stock returns. We investigate whether short sellers are also informed when they exit their positions. Using publicly disclosed data of
net short positions from European stock markets, we find that short covering trades are associated with positive price reaction and future abnormal returns depend on short sellers’ profit-and-loss (PnL) at the time of exiting their positions. We document that when short sellers close profitable short positions, future abnormal returns are positive. However, when short sellers cover trades that have moved against them, future abnormal returns are negative. Our results suggest that short sellers are, generally, informed when covering their shorts, but sometimes they may be “squeezed out” of their positions prematurely.

A number of European countries - Austria, Belgium, France, Greece, Italy, and Spain - responded to the market disruption caused by the Covid-19 pandemic by introducing temporary bans on short-selling activity. These restrictions were imposed on all stocks and remained in place between March 18 and May 18 across all six countries. Other European countries, unlike the 2007-09 global financial crisis, abstained from introducing any form of short-selling constraints. We exploit this cross-country variation in short-sale regimes to identify their effects on liquidity, price discovery, and stock prices. We find that bans were detrimental for liquidity and failed to support prices, in line with the early work of Beber and Pagano (2013).