Pricing inefficiencies on the short side of equity trade?

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Really have a hard time to understand what it is.
Schweser says: These inefficiencies include:
1. impediments to short sells.
2. management is likely to promote firm’s stock
3. analysts more likely to issue buy than sell recommendations.
4. pressure from analysts to issue sell recommendations.
What does it mean by pricing inefficiencies? Isn’t there is only one stock price? Both short and long trade on the same price? This is very confusing… Any help is greatly appreciated.
 
Everybody is the market is permitted to go long a stock (which is a vote for a price increase). Not everybody is permitted to go short (which is a vote for a decrease). The best some firms can do is a sell order. While this is a vote for a decrease it is not as big of a vote as a short.
So if you believe the price of a stock is too high you might want to short but can’t. If enough people in the market have this restriction then prices may be artifically high.
 
lxwqh:
Try to first dissect the word:
Pricing = on its own pretty self explanatory
Inefficiency = not efficient
So taken together, the quoted price is not at its equilibrium price due to some sort of inefficiency. The author is referring to both structual and psychological impediments that act as natural barriers to achieving full price efficiency.
1. mutual funds cannot engage in short sales, thus, are unlikely to scour the area
2. the masses generally do not question corporate cheerleaders unless given a reason. This corporate cheerleading creates a positive bias in stock price.
3. same thing with analysts. Its been documented that sell-side analysts are overly-optimistic due to a variety of reasons (job security, investment banking relationships, fear of getting black-balled from company conference calls - which act as an information conduit, etc)
4. whats this last one???
Because of the structure of the short market, the opportunities are less pored over. Similar to the small cap or micro cap markets. Because there are less eyes analyzing potential opportunities, there are more chances for the investor to identify good values (in this case on the short side).
Also, think about using spin-offs as an analogy. Lets say company XY (composed of one part X and one part Y) comprise a single firm. X’s business dwarfs Y’s business. Yet, Y is amazingly profitable, but since its so tiny in comparison, its not being fully valued by the market place. XY decides to spin-off Y. Now, the orignal holders of XY operate primarily in the large cap space lets say. Their investment mandate dictates that they must divest company Y once its trading independently. Forced selling is a structural inefficiency that allow savvy investors to capitalize on selling pressure and reap opportunities in less traveled markets.
Hope this helps.
 
These explanations are beautiful and very convincing. Thanks to both of you guys for your time and attention. I love reading them more than Schweser.
 
The pricing inefficiency is in regards to asymmetry that potentially exists in long-short relationships. Long positions are well researched, purchased by anyone and everyone, and recommended quite often. Also, the public is eager to find cheap underpriced stocks as opposed to expensive overpriced stocks. Now add in the fact, that many can’t invest in short positions (pension funds, etc.), there is a lack of real research on short positions, and the fact that pressure is on analysts to only issue buy recommendations or not change existing recommmendations to sell recommendations. This infers that there is less trasnparency and priced in information on short positions, allowing for a potentially higher return.
 
Sorry, for this statement - “the masses generally do not question corporate cheerleaders unless given a reason. This corporate cheerleading creates a positive bias in stock price.”
To quote CFAI on the same point mentioned above - ”Second, opportunities to short a stock may arise because of management fraud, “windowdressing” of accounts, or negligence. Few parallel opportunities exist on the long side because of
the underlying assumption that management is honest and that the accounts are accurate. Rarely
do corporate managers deliberately understate profits.”
How does this result in price inefficiency for the shortist?
 
Suppose that you have 100 investors interested in ABC Company stock. Fifty of those investors think that ABC stock is undervalued, so they buy it. The other 50 think that it is overvalued, so they’d like to sell it short. However, 40 of those who think that it’s overvalued are prohibited from short selling, so they do nothing. The result is 5 times as many investors pushing the price up as those pushing the price down. It’s likely to go up, and the short sellers lose out, even if they’re correct.
 
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