Short-Sale Constraints and Securities Lending by Exchange-Traded Funds

Abstract:     
A stock's inclusion in an ETF has the potential to reduce its short sale constraints by decreasing search costs and lowering recall risk. This paper examines how the introduction of ETFs impacts short interest levels of their constituent stocks. We find that short selling in the underlying securities significantly increases after ETFs are introduced. The increase in short interest is largest for firms which are most short-sale constrained prior to the inclusion. The analysis of subsequent additions of stocks to ETFs reveals that the effect of increased short interest is significantly attenuated when compared to the first-time additions. Overall, our evidence suggests that the introduction of ETFs helps to alleviate short-sale constraints for stocks that they hold.

Keywords: Exchange-traded funds, short-sale constraints, short interest, securities lending

JEL Classification: G14, G23

Accepted Paper Series