Can Short-Selling Alleviate the Underpricing?

This paper investigates whether short-selling facilitates arbitrage activity and mitigates the positive post-earnings announcement drift (PEAD), the well-known underpricing anomaly. Using the quarterly earnings announcement of the Korean Stock Exchange KOSPI200 composite stocks, we find that the positive earnings stock in a difficult- to-short industry experiences the larger and more persistent underpricing after earnings announcement than those in an easy-to-short industry; and that the severe underpricing in a difficult-to-short industry is associated with the short-sale constraint, not with their illiquidity or information inefficiency. We also find that the inverse relationship between the positive PEAD and its industry’s short-ability is stronger during the inactive ELW trade period, weaker during the active ELW trade period. Our findings suggest that short-selling help not only the overpriced stocks but also the underpriced stocks revert back to its fundamental value by facilitating arbitrage activities.