Do short sellers exacerbate volatility?

Purpose: This paper examines whether short sellers aggravate volatility in the Australian stock market by using five different realized volatility (RV) measures during a more stable period. Design/methodology/approach: The authors develop a measure to capture the abnormal level of short selling for each stock and examine the bivariate and trivariate dynamic relationships between abnormal short selling and five volatility measures: the RV, continuous and jump components of RV, upside and downside volatilities. Findings: Overall, the findings indicate a weak association between abnormal short selling and volatility. Where the relationships are significant, the authors generally find that lagged abnormal short selling is negatively associated with both upside and downside volatilities. In general, short selling does not drive or amplify the decline in stock prices. Originality/value: This paper contributes to existing literature in various aspects. First, the authors offer evidence on the relationship between abnormal short selling and volatility in a general market condition while existing studies often found mixed results of the effects of short selling on volatility around extreme events. Second, the authors add to the literature on the volume-volatility relation by introducing abnormal short selling. Although abnormal short volume does not supplant the number of trades in the volume-volatility relation, it has some incremental, albeit negative, effect on volatility. Finally, the study provides further evidence for the debate on the desirability of short sellers in financial markets.