Short Selling : Strategies, Risks, and Rewards PDF
Preview Short Selling : Strategies, Risks, and Rewards
ffirs.frm Page iii Thursday, August 5, 2004 10:42 AM Short Selling Strategies, Risks, and Rewards FRANK J. FABOZZI EDITOR John Wiley & Sons, Inc. Sect1 Page 8 Thursday, August 5, 2004 10:45 AM ffirs.frm Page i Thursday, August 5, 2004 10:42 AM Short Selling ffirs.frm Page ii Thursday, August 5, 2004 10:42 AM THE FRANK J. FABOZZI SERIES Fixed Income Securities, Second Edition by Frank J. Fabozzi Focus on Value: A Corporate and Investor Guide to Wealth Creation by James L. Grant and James A. Abate Handbook of Global Fixed Income Calculations by Dragomir Krgin Managing a Corporate Bond Portfolio by Leland E. Crabbe and Frank J. Fabozzi Real Options and Option-Embedded Securities by William T. Moore Capital Budgeting: Theory and Practice by Pamela P. Peterson and Frank J. Fabozzi The Exchange-Traded Funds Manual by Gary L. Gastineau Professional Perspectives on Fixed Income Portfolio Management, Volume 3 edited by Frank J. Fabozzi Investing in Emerging Fixed Income Markets edited by Frank J. Fabozzi and Efstathia Pilarinu Handbook of Alternative Assets by Mark J. P. Anson The Exchange-Traded Funds Manual by Gary L. Gastineau The Global Money Markets by Frank J. Fabozzi, Steven V. Mann, and Moorad Choudhry The Handbook of Financial Instruments edited by Frank J. Fabozzi Collateralized Debt Obligations: Structures and Analysis by Laurie S. Goodman and Frank J. Fabozzi Interest Rate, Term Structure, and Valuation Modeling edited by Frank J. Fabozzi Investment Performance Measurement by Bruce J. Feibel The Handbook of Equity Style Management edited by T. Daniel Coggin and Frank J. Fabozzi The Theory and Practice of Investment Management edited by Frank J. Fabozzi and Harry M. Markowitz Foundations of Economic Value Added: Second Edition by James L. Grant Financial Management and Analysis: Second Edition by Frank J. Fabozzi and Pamela P. Peterson Measuring and Controlling Interest Rate and Credit Risk: Second Edition by Frank J. Fabozzi, Steven V. Mann, and Moorad Choudhry Professional Perspectives on Fixed Income Portfolio Management, Volume 4 edited by Frank J. Fabozzi The Handbook of European Fixed Income Securities edited by Frank J. Fabozzi and Moorad Choudhry The Handbook of European Structured Financial Products edited by Frank J. Fabozzi and Moorad Choudhry The Mathematics of Financial Modeling and Investment Management by Sergio M. Focardi and Frank J. Fabozzi ffirs.frm Page iii Thursday, August 5, 2004 10:42 AM Short Selling Strategies, Risks, and Rewards FRANK J. FABOZZI EDITOR John Wiley & Sons, Inc. ffirs.frm Page iv Thursday, August 5, 2004 10:42 AM Copyright © 2004 by John Wiley & Sons, Inc. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or oth- erwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rose- wood Drive, Danvers, MA 01923, 978-750-8400, fax 978-646-8600, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Per- missions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201- 748-6011, fax 201-748-6008. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies con- tained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services, or technical support, please con- tact our Customer Care Department within the United States at 800-762-2974, outside the United States at 317-572-3993, or fax 317-572-4002. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley, visit our web site at www.wiley.com. ISBN: 0-471-66020-5 Printed in the United States of America 10 9 8 7 6 5 4 3 2 1 ftoc.frm Page v Thursday, August 5, 2004 10:40 AM Contents Foreword ix Clifford S. Asness Preface xiv About the Editor xv Contributing Authors xvi CHAPTER 1 Introduction 1 Frank J. Fabozzi, Steven L. Jones, and Glen Larsen SECTION ONE The Mechanics of Short Selling 7 CHAPTER 2 Mechanics of the Equity Lending Market 9 Jeff Cohen, David Haushalter, and Adam V. Reed The Lending Process 10 Lenders 11 Borrowers 13 The Determinants of Rebate Rates 15 Conclusion 16 CHAPTER 3 Shorting Using Futures and Options 17 Frank J. Fabozzi Futures Contracts 17 Equity Options 30 Summary 36 v ftoc.frm Page vi Thursday, August 5, 2004 10:40 AM vi Contents CHAPTER 4 Is Selling ETFs Short a Financial “Extreme Sport”? 37 Gary L. Gastineau What Are the Most Important Safety Features Protecting ETF Short Sellers? 38 How Do ETFs Work in Risk Management Applications? 39 Who Owns ETF Shares? 43 Will It Always Be Possible to Borrow ETF Shares at Low-Cost for Risk Management Applications? 47 What Is the Effect of Short Selling and Risk Management Activity on ETF Trading Volume and Trading Costs? 49 Are Risk Management Applications and Heavy ETF Share Trading Desirable for Fund Shareholders and Fund Advisors? 51 What Is the Significance of the Short Interest for Growth in ETF Assets? 52 Conclusion 56 SECTION TWO Theory and Evidence on Short Selling 59 CHAPTER 5 Restrictions on Short Selling and Exploitable Opportunities for Investors 61 Edward M. Miller Demand and Supply Curves Arguments 62 The Pattern of Stock Prices Over Time with Uninformed Investors 75 The Bounded Efficient Markets Hypothesis 91 Conclusions 114 CHAPTER 6 Implications of Short Selling and Divergence of Opinion for Investment Strategy 117 Edward M. Miller Interaction of Divergence of Opinion and Short Selling Restrictions 119 Empirical Tests 134 Conclusions 176 CHAPTER 7 Short Sale Constraints and Overpricing 179 Owen A. Lamont Short Sale Constraints 180 The Overpricing Hypothesis 184 Costs of Shorting 188 Go Down Fighting 191 3Com/Palm 193 Tech Stock Mania and Short Sale Constraints 200 Summary 203 ftoc.frm Page vii Thursday, August 5, 2004 10:40 AM vii Contents CHAPTER 8 How Short Selling Expands the Investment Opportunity Set and Improves Upon Potential Portfolio Efficiency 205 Steven L. Jones and Glen Larsen Short Selling in Efficient Portfolios: The Theory and Its Practical Implications 207 The Empirical Evidence on Short Positions in Ex Post Efficient Portfolios 229 Concluding Remarks and Practical Implications for Investors 231 CHAPTER 9 The Information Content of Short Sales 233 Steven L. Jones and Glen Larsen Short Sales: Reporting, Frequency, and Constraints 235 Academic Theory versus the Technical Analyst’s View 236 The Empirical Evidence 239 Conclusions and Implications for Investors 253 SECTION THREE Short Selling Strategies 257 CHAPTER 10 Spotting Clues in Qs 259 Ron Gutfleish and Lee Atzil Looking for the Easier Fight 260 Putting on the Green Eyeshades 261 So What? It’s Only Accounting 265 How Do You Find these Cases? 266 Diagnosis 270 Keeping Your Shorts On 270 Tales from the Front Lines: Three Examples 271 Summary 278 CHAPTER 11 The Economic Profit Approach to Short Selling 279 James A. Abate and James L. Grant Short Selling in the Theory of Finance 280 Tenets of Good and Bad Companies 280 Positive NPV: Discovery of Good Companies 281 Negative NPV: Discovery of Bad Companies 284 Zero NPV: Wealth Neutral Companies 287 Case Studies 287 Role of the Value/Capital Ratio 291 Invested Capital Growth 292 Managerial and Investor Implications 294
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