We study the association between daily changes in short selling activity and financial stock prices during extreme events using TailCoR, a measure of tail correlation. For the largest European and US banks, as well as European insurers, we uncover a strong relation during exceptional (extreme) days and a weak relation during normal (average) days. Examining days with large increases in short positions and large downfalls in stock prices, we find evidence of both momentum and contrarian short selling taking place. For North American bank stocks, contrarian short selling appears more practiced than for European bank and insurance stocks. We find that the uncovered relationship decreases with firm size and increases during ban periods, which is in line with short selling becoming more informative when constrained.

We propose a market-based framework that exploits time-varying parameter vector autoregressions to estimate the dynamic network of financial spillover effects. We apply it to financials in the Standard & Poor’s 500 index and estimate interconnectedness at the sectoral and institutional levels. At the sectoral level, we uncover two main events in terms of interconnectedness: the Long-Term Capital Management crisis and the 2008 financial crisis. After these crisis events, we find a gradual decrease in interconnectedness, not observable using the classical rolling-window approach. At the institutional level, our framework delivers more stable interconnectedness rankings than other comparable market-based measures.