College of Business Administration, Northeastern University, 413 Hayden Hall, Boston, MA 02115, USA Tel: +1 617 3734740; Fax: +1 617 3738798; e-mail: h.platt@neu.edu

Received 31 July 2003.

Abstract

The expression 'greed and fear move markets' is commonly cited to explain trading activity. In this paper, greed and fear form the intellectual basis of a theory explaining short selling activity. The theory describes two independent demands for shares to short sell, one based on future price expectations and one based on financial distress. With the number of shares available to be borrowed rigidly determined by institutional factors, the theory focuses on the quantity of shares shorted. An empirical test of the theory is conducted using a sample of bankrupt companies. The theory's implications are supported by the data and lend strong credence to the importance of greed and fear among short sellers.