A cloudy day in the market: short selling behavioural bias or trading strategy

Abstract

PurposeResearch draws the distinction between noise traders and informed traders. Research also documents market biases in equity returns due to cloud cover, a non‐informational (noise) event, showing that returns decrease on cloudy days. The purpose of this paper is to investigate the trading behaviour of short‐sellers, who are considered informed traders, conditioning on the level of cloudiness, and find an increase in short selling with the level of cloudiness. Additionally, the paper finds decreases in short selling the three days prior to a cloudy day (or series of cloudy days).Design/methodology/approachThe authors replicate the weather anomaly in stock returns reported in the literature for the sample period, and then study the trading behaviour of short sellers conditioned on cloud cover. Additionally the authors treat cloud cover as an event and study short selling volume in the pre‐event window.FindingsThe paper finds an increase in short selling with the level of cloudiness. Additionally, the paper finds decreases in short selling, relative to the event day(s), in the three days prior to a cloudy day (or series of cloudy days).Originality/valueThe authors believe that they are the first to document that weather impacts short seller's trading behaviour. The authors argue that the results point towards a behavioural bias.

Sadder But Wiser: The Effects of Affective States and Weather on Ambiguity Attitudes

“…The most common explanation for these phenomena is that investors' moods could be influenced by these exogenous events (e.g., due to seasonal affective disorder), which may influence their risk preferences and in turn influence investment decisions and market outcomes. Yet, Watson and Funck (2012) showed that short selling (a risky investment strategy) by professional traders actually increases on cloudy days, but not on the three prior days before the cloudy event. This suggests that professional traders do not correctly anticipate downward market movements based on weather forecasts.…”

Comparing uncertainty aversion towards different sources

“…It is not clear whether this is because it affects traders' perceived likelihood of future events or because it affects their intrinsic willingness to bear uncertainty. Watson and Funck (2012) showed that short selling by (professional) traders increases on cloudy days, suggesting that they are more willing to bet against stocks going up. In the light of our definition, this suggests that the impact of cloudiness on stock returns is caused by a change in beliefs, rather than a higher degree of uncertainty aversion.…”

Let the Sunshine In? The Effects of Luminance on Economic Preferences, Choice Consistency and Dominance Violations

“…While less is known about changes in financial risk taking and mood, we know that positive mood states have been associated with more conservative behavior in risky tasks involving financial rewards [21][22][23]. There is market evidence that even professional traders change their investment strategies (increase short selling) on more cloudy days [12]. ambiguity aversion probability equivalent for an ambiguous gamble with 50% wining probability cloudiness (0 for clear sky to 9 maximum coverage) precipitation, sunshine and temperature 0.12 increase no effect…”

“…At an economic level, there is also now some direct evidence that light levels influence human choice. A growing body of literature has shown, for example, that weather and seasons affect economic outcomes in financial markets [9][10][11][12][13][14]. Table 1 summarizes what we have learned so far in terms of the impact of weather on financial decision-making.…”