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S. Huang, T. Lin, W. Zheng: Substitution between Short Selling and Options Trading in Predicting Aggregate Stock Returns

May 31, 2019

Splitting stocks into groups with and without options trading, we find that only the aggregate short interest index constructed by the stocks without options trading predicts market returns in both in-sample and out-of-sample tests. The return predictability is up to six months and does not revert. Similarly, when splitting stocks into groups based on short selling risks, we find only the aggregate option implied volatility spread constructed by the stocks with higher short selling risks predicts market returns.

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