The Wisdom of Crowds of Short Sellers

A new NBER paper  by a Dream Team of economists documents the wisdom of short selling crowds.  Here is their abstract:

“We study the predictive power of approximately 2.5 million stock picks submitted by individual users to the “CAPS” website run by the Motley Fool company ( These picks prove to be surprisingly informative about future stock prices. Indeed, a strategy of shorting stocks with a disproportionate number of negative picks on the site and buying stocks with a disproportionate number of positive picks produces a return of over nine percent per annum over the sample period. These results are mostly driven by the fact that negative picks on the site strongly predict future stock price declines; positive picks on the site produce returns that are statistically indistinguishable from the market.”

Some nations in Europe are considering banning short sales.   Price discovery is an important function of asset prices. In the case of recent housing price dynamics, real estate experts agree that optimists were able to signal their beliefs (by buying) while pessimists were not able to short housing.  I know that Mark K. did sell his house but he couldn’t sell 10,000 homes.   If there were thick futures markets in trading the Case-Shiller index, then optimists would see that some bets disagree with their expectations and “rational optimists” would think twice before placing their own big bet on rising asset values. 

Author: Matthew E. Kahn

Professor of Economics at UCLA.

4 thoughts on “The Wisdom of Crowds of Short Sellers”

  1. Of course, if banks that make mortgage loans were not run by crooks, that also might put a damper on house prices. And, if derivatives were regulated, or banned altogether, “shorts” structured along the lines of the infamous Magnetar Trade would not have magnified the bubble at the top, instead of dampening it, as shorts are supposed to. If . . .

  2. All investments are “bets.” But when outright betting, generally with other peoples’ money, becomes the primary mechanism by which the hypertrophied FIRE segment of the economy takes its “profits,” we are screwed. Period. And all the Chicago School claptrap in the universe will not change that.

  3. Repackaging mortgages leads to moral hazard (this time it isn’t poor people engaging in risky behavior while being shielded from the consequences, so I imagine an economist would call this “doing business” instead), so the proper response is to ban the practice or require that the banks issuing mortgages keep some significant fraction of the loans they issue (50%+, I’d reckon). Then, you can tackle the culture of home ownership being the only path to being a “proper American” and then you can tackle 30 years of flat wages and then, finally, you can start talking about the benefits of shorting a market. Its got to be healthy first!

  4. …a Dream Team of economists documents the wisdom of short selling crowds.

    I’m not sure “wisdom” is the proper word to associate with a herd.
    Wisdom represents an amalgamation of hard-won insights tempered by the heart and cooled by justice…

    Try this on instead: …a Dream Team of economists documents the “self-fulfilling prophecy” of short selling crowds.

    Recall the genius comic Krugman ran the other day on his blog:
    (Make sure you see the little guy in the bottom right hand corner)

    The comic represents amalgamated “wisdom” about crowds.
    And interesting enough, it depicts the “self-fulfilling prophecy” inherent in crowds.

    That’s why Krugman remembered and held on to it.
    It is eternal. A classic born of wisdom…

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