The Market for Borrowing Stock

Abstract

To short a stock, an arbitrageur must first borrow it. This paper describes the market for borrowing and lending U.S. equities, with an emphasis on the conditions generating and sustaining short sales constraints. Eighteen months (4/2000-9/2001) of daily data provided by a large institutional lending intermediary establish a rich set of facts on loan supply ("shortability"), loan fees ("specialness"), and loan recalls. The data suggests that while loan market specials and recall are rare on average, the incidence of these short sales constraints is increasing in the divergence of opinion among investors. An implication is that beyond some threshold, investor optimism itself can limit arbitrage via the loan market mechanism.

Keywords: Short sales constraints, securities lending, limits to arbitrage, divergence of opinion

JEL Classification: G12, G14