The Term Structure of Short Selling Costs

Abstract

I derive the term structure of short selling costs using the put-call parity relationship. The shape is determined by informed investors' beliefs of when negative information will enter the market and correct the overpricing. I show that forward costs predict future costs and stock returns, consistent with the expectations hypothesis in the model. I also find that an upward slope around the earnings announcement increases the probability of a negative earnings surprise by 9.3%, supporting the prediction that short selling costs are higher over horizons when negative information is more likely to arrive. My findings suggest that the term structure of short selling costs conveys how long overpricings are expected to persist.

Keywords: short sale, equity lending, limits to arbitrage, information in option prices, behavioral asset pricing

JEL Classification: G12, G14