Time‐Varying Aggregate Short‐Selling in Korea

• Author: Shu‐Feng Wang,Kuan‐Hui Lee
• Date: 01 October 2019
• DOI: http://doi.org/10.1111/ajfs.12273
• Published date: 01 October 2019

Time-Varying Aggregate Short-Selling in

Korea*

Kuan-Hui Lee

Business School, Seoul National University, Republic of Korea

Shu-Feng Wang**

Business School, Ajou University, Republic of Korea

Received 14 November 2018; Accepted 30 July 2019

Abstract

This study examines the variation in aggregate short-selling by foreigners, individuals, and

institutional investors in relation to market return and other market-wide variables in the

Korean stock market. First, we find that aggregate short-selling has strong seasonal compo-

nents. In contrast to the existing literature, which shows contrarian-style short-selling at the

stock level, we find momentum-style short-selling by foreigners and individual investors at

the aggregate level. That is, they significantly increase their short-selling following a short-

term down market. In addition, we show that past US market return is negatively related to

aggregate short-selling by foreign investors. Vector-autoregression and impulse-response anal-

yses reveal that aggregate short-selling is significantly affected by changes in market return,

but not vice versa.

Keywords Short-selling; Foreign investors; Individual investors; Momentum; Korean stock

market

JEL Classification: G12

1. Introduction

In this paper, we examine aggregate short-selling by investor types in the Korean

stock market. By investor types, we mean foreign investors, domestic individual

*We thank Daehwan Kim (discussant) and conference participants at the APAD (2018). We

thank Victor Son for his excellent research assistance. Lee appreciates the financial support

from the Institute of Management Research and the Institute of Finance and Banking at

Seoul National University. Wang appreciates the financial support from the new faculty fund-

ing of Ajou University. This paper has also been circulated under the title “Foreign vs.

Domestic: Variation of Aggregate Short-Selling in Korea.” Any errors herein are our own.

**Corresponding author: Assistant Professor of Finance, Business School, Ajou University,

206 Worldcup-Ro, Yeongtong-Gu, Suwon, 16499, Republic of Korea. Tel: +82-31-219-2913,

Fax: +82-31-219-1616, email: sfwang@ajou.ac.kr.

Asia-Pacific Journal of Financial Studies (2019) 48, 690–720 doi:10.1111/ajfs.12273

690 ©2019 Korean Securities Association

investors, and domestic institutional investors. While a vast literature focuses on

each of these investor types separately, studies combining the trades from multi-

ple investor types to examine the dynamic relations between them are rare. How-

ever, it is important to consider various investor types together because foreign

investors, institutional investors, and individual traders display demonstrably dif-

ferent characteristics in their trading. Thus, significant interaction among them is

quite plausible. According to Brennan and Cao (1997), foreign investors are

forced to be positive feedback or momentum traders due to their informational

disadvantage relative to domestic investors. Supporting this view, Grinblatt and

Keloharju (2000) and Griffin et al. (2007) provide supporting empirical evidence

on foreign investors’ momentum trading behavior. On the contrary, individual

investors are typically regarded as random or noise traders (Odean, 1999; Barber

and Odean, 2000; Barber et al., 2009; Foucault et al., 2011), though other

researchers find evidence that individual investors are privately informed and that

the trading by individuals can help improve price efficiency (Coval et al., 2005;

Dhar and Zhu, 2006; Griffin and Zhu, 2006; Boehmer et al., 2008; Kaniel et al.,

2008, 2012; Nicolosi et al., 2009).

We focus exclusively on short-selling at the aggregate level in this study. Analy-

ses at the aggregate level enable us to examine the dynamic nature of time variation

of short-selling in relation to market return, volatility, and other market-wide vari-

ables. Given that short-selling is generally riskier than taking a long position, aggre-

gate short-selling can be more sensitive to the changes in market environment than

its long counterpart. Studies on short-selling at the aggregate level are, however,

rare. Lynch et al. (2014) and Rapach et al. (2016) show that aggregate short-selling

predicts market returns in the United States, while Lamont and Stein (2004) show

that aggregate short-selling in the United States is counter-cyclical and negatively

related to market return. We contribute to the existing literature by investigating

how short-selling behavior at the aggregate level in the Korean stock market is

related to stock market return and market-wide variables. Furthermore, we examine

aggregate short-selling in relation to changes in the global economic environment.

In doing so, we examine aggregate short-selling by different investor types: individ-

uals, foreigners, and institutions. To the best of our knowledge, this is the first

paper that investigates how aggregate short-selling by investor types is related to the

global market environment. As in Wang and Lee (2015), this paper shows that a

major portion of short-selling trading in the Korean stock market is executed by

foreign investors. Since foreign short-sellers are generally largely exposed to global

or US economic conditions, it is quite likely for them to adjust their short-selling

in response to changes in the global economic environment. We can investigate this

issue more explicitly at the aggregate level. We ask the following research questions:

Are there any seasonal patterns in aggregate short-selling? Are the patterns of aggre-

gate short-selling different across investor types? Is there a dynamic relation among

aggregate short-selling based on different investor types and market conditions? Are

short-sellers in Korea affected by the global—for instance, the US—market return?

Aggregate Short-Selling

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