Does Short Selling Amplify Price Declines or Align Stocks with Their Fundamental Values?

We examine whether short sellers predominantly target stocks with recent price declines, amplifying the price decline and resulting in prices falling below fundamental values, or target apparently overpriced stocks facilitating prices that reflect fundamental values. We find evidence of short-sellers holding significant positions in stocks following price declines, and of short-sellers increasing their positions while the stock price is declining. When we condition on fundamental value, however, we do not find any reliable evidence that the targets of short-sellers are trading below their fundamental values. Instead a significant proportion of short-sellers’ positions are concentrated in stocks that appear overvalued relative to their fundamentals. While there is significant heterogeneity in the positions of short-sellers, including large positions in stocks with price declines, we find compelling evidence that a significant proportion of short positions following price declines appear to align prices with fundamentals rather than force prices below fundamental values.