However, to the extent that academics have studied short interest, contrary to the cushiontheory, these studies report a robust negative relationship between short interest and short-termfuture returns (see for example, Figlewski and Webb (1993), Senchack and Starks (1993),Asquith and Meulbroek (1995), Dechow et al. (2001), and Desai, Ramesh, Thiagarajan, andBalachandran (2002)). These studies have not explicitly sought to explain whether shortsqueezes occur. Indeed, our search of academic literature uncovered no studies that empiricallyidentify the frequency and magnitude of short squeezes.
The prevalence of short squeezesreferenced in the popular media and the absence of systematic evidence of short squeezes inacademic studies give rise to the question of whether short squeezes are the Sasquatches of financial markets – phenomena that are much discussed but never seen.In this paper we attempt to systematically document evidence of short squeezes in individualequities. In a sample of 26,343 events where liquid stocks experience a one-day return of 15%or more
, we find that, after adjusting for risk, the next day prices experience an average reversalof -0.30% Moreover, the absolute value of the next day price reversal increases with the level of short interest and the magnitude of the prior day price jump (i.e. the event-day return);specifically, when both short interest and event-day return are in the highest decile, stocksexperience the largest price reversal of -3.25%. In contrast, for stocks with low short interest,prices increase, on average, by a small but insignificant amount on the day following the price
D’Avolio (2002) studies a different kind of short squeeze where the borrowed stocks by short sellers are calledback by their original owner.
Illiquid stocks are actually more likely to be bound by the two necessary constraints. Moreover, in the unreportedresults, we find the effect of squeeze to be stronger for illiquid stocks. However, these stocks also have wide bid-ask spreads, which muddle the effect of short squeezes. For this reason, we choose to focus on liquid stocks to have aclear measure of the squeeze impact.