A Multiple Lender Approach to Understanding Supply and Search in the Equity Lending Market

Abstract

Although a large body of research has investigated the effects of short sale constraints, very little is understood about the origin of these constraints in the one-trillion-dollar equity lending market. Using a unique database comprising data from twelve lenders, we find significant dispersion in share loan fees across lenders, and we find that the dispersion is increasing in share loan demand and various proxies for search costs, including a stock's illiquidity and the number of small lenders making loans. These findings are consistent with the existence of search frictions between share borrowers and lenders, as Duffie, Garleanu, and Pedersen (2002) suggest. We further analyze the effect of search frictions by examining the response of shorting cost to exogenous shocks in demand. We find that for stocks with moderate demand, loan fees are largely insensitive to demand shocks. However, for stocks with high demand, an increase in demand triples the already higher abnormal loan fees. Our findings help reconcile seemingly conflicting findings in the literature regarding the existence of both small and large effects of shifts in demand on price. We highlight the importance of search costs by showing that the various parameters in firms' share loan supply schedules are closely related to crosssectional differences in search costs. We conclude that short sale constraints could be slackened by the reintroduction of a central clearinghouse of share loans, which would reduce search costs.

Can Short Restrictions Actually Increase Informed Short Selling?

“…LOAN-QTY is daily shares lent scaled by shares outstanding. Finally, following Kolasinski et al (2011), SEARCHCOST is the firm-specific standard deviation of SPECIALNESS across lenders on a given day. This table presents summary statistics on variables used in our analyses.…”

“…Furthermore, dispersion in loan fees increased by 33% indicating that search costs to borrow a stock increased significantly. Increased search frictions likely give an advantage to sophisticated, informed short sellers who are more likely to have relationships with equity lenders (Kolasinski, Reed, and Ringgenberg, 2011). Therefore, there is good a priori reason to expect that the EO increased the ratio of informed to uninformed short sellers, making it a candidate for the short restriction effect of DV.The second regulation, which we call the ban, prohibited all market participants except market makers from short selling financial stocks from Although the ban prohibited shorting in the underlying stock, as Battalio and Schultz (2011) point out, the options market provided an alternative though costly means of acquiring short exposure.…”

“…Furthermore, dispersion in loan fees increased by 33% indicating that search costs to borrow a stock increased significantly. Increased search frictions likely give an advantage to sophisticated, informed short sellers who are more likely to have relationships with equity lenders (Kolasinski, Reed, and Ringgenberg, 2011). Therefore, there is good a priori reason to expect that the EO increased the ratio of informed to uninformed short sellers, making it a candidate for the short restriction effect of DV.…”

How Informed Investors Take Advantage of Negative Information in Options and Stock Markets

“…In other words, the reduced liquidity due to aggressive informed trades makes information asymmetry greater so that bid-ask spreads will increase (Bloomfield, O'Hara, & Saar, 2005). Short sale fees are another transaction costs and have also been used in the previous studies as an indicator for the increase in informed trades, especially trades with negative information (Kolasinski, Reed, & Ringgenberg, 2008).…”

Securities Lending as Wholesale Funding: Evidence from the U.S. Life Insurance Industry

“…3 In addition, the securities lending market has been studied empirically to better understand the connections between the securities lending market and pricing in the securities market (including, for example, D'avolio (2002), Nashikkar & Pedersen (2007), Saffi & Sigurdsson (2011), Asquith, Au, Covert & Pathak (2013), Kaplan, Moskowitz & Sensoy (2013), and Kolasinski, Reed & Ringgenberg (2013)), and has been exploited to study equity We offer compelling evidence for an alternative, supply-driven, motive for securities lending.…”