The Shorting Premium and Asset Pricing Anomalies

Abstract

Short rebate fees are a strong predictor of the cross-section of stock returns, both gross and net of fees. We document a large "shorting premium": the cheap-minus-expensive-to-short (CME) portfolio of stocks has a monthly average gross return of 1.31%, a net-of-fees return of 0.78%, and a 1.44% four-factor alpha. We show that short fees interact strongly with the returns to eight of the largest and most well-known cross-sectional anomalies. The anomalies effectively disappear within the 80% of stocks that have low fees, but are especially large among the high-fee stocks, even net of fees. We propose an explanation for these findings: the shorting premium is arbitrageurs' compensation for the concentrated risk they bear in shorting overpriced stocks. Because this risk is on the short side, a larger premium means a more overpriced stock. We proxy for shorting risk using stocks' covariance with the CME portfolio, and demonstrate that a Fama-French CME factor model largely captures the anomalies' returns within both high- and low-fee stocks.

Keywords: shorting, lending fees, shorting premium, anomalies, cross-section, asset pricing, concentrated risk, differences of opinion, segmentation, stock returns, value, momentum, idiosyncratic volatility, net share issuance

JEL Classification: G11, G12, G14