The Role of Market Infrastructure in Price Discovery: Short Sellers’s Perspective

Abstract

This study shows that short sale trades in the new BATS exchanges have significant return predictability beyond the well-established short-sale demand and short-sale constraints measures. Specifically, we report 57 (43) bps monthly value-weighted (equal-weighted) abnormal returns on the long-short high-low BATS short portfolio, where both the long and short legs of the strategy contribute to the profits. More importantly we show that the return predictability emanates from the two exchanges with traditional market maker fee structures. In the context of these two markets, in the institutional market the level of short selling is informative while in the retail setting the change in short selling conveys information. Addressing the SEC’s Transaction Fee Pilot project objectives, our results shed light on how market makers compensations play a role in the information discovery of relatively informed traders, short sellers.