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Days to Cover and Stock Returns

Days to Cover and Stock Returns by Wesley R. Gray, Ph.D., Alpha Architect, Author of Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors.


The short ratio — shares shorted to shares outstanding — is an oft-used measure of arbitrageurs’ opinion about a stock’s over-valuation. We show that days-to-cover (DTC), which divides a stock’s short ratio by its average daily share turnover, is a more theoretically well-motivated measure because trading costs vary across stocks. Since turnover falls with trading costs, DTC is approximately the marginal cost of the shorts. At the arbitrageurs’ optimum it equals the marginal benefit, which is their opinion about over-valuation. DTC is a better predictor of poor stock returns than short ratio. A long-short strategy using DTC generates a 1.2% monthly return.

Betting Against Short Interest?

Literature shows that betting against stocks with high short interest (shares sold short/shares outstanding) generates future stock premiums. That’s probably because high short interest ratios may indicate the presence of information suggesting fundamental values are lower than the market indicates. What’s more, people believe that short sellers are mostly professionals and arbitrageurs who are more informed.

Researchers are showing a growing interest in the short ratio...