How Do Short Selling Costs and Restrictions Affect the Profitability of Stock Anomalies?

Abstract

Short selling frictions cannot explain the persistence of seven prominent stock anomalies. Long-only investing is robust and profitable and can be further enhanced by using a synthetic short. Moreover, portfolios restricted to stocks that are easy to short sell continue to have large and significant short anomaly alphas. The paper derives cost bounds for switching between implementation methods and shows that the cost associated with short anomaly positions is small relative to their profitability contribution using a proprietary database of borrowing fees. Overall, the empirical evidence does not support the implications of arbitrage asymmetry that mispricing is concentrated in short positions where it is too costly to exploit.

Keywords: short selling restrictions, short selling costs, factors, anomalies, limits to arbitrage

JEL Classification: G1, G10, G11, G12, G14, G23