Distortions Caused by Institutional Securities Lending
38 Pages Posted: 6 Dec 2017
Date Written: November 30, 2017
Mutual funds and ETFs that lend their shares to short-sellers often retain a fraction of the resulting fees rather than returning them to investors, incentiving them to overweight stocks with high lending fees. In a heterogeneous agent model, we show this incentive distorts equilibrium portfolio choices, fund performance, and asset pricing. Our model explains many empirical patterns: lending funds’ overweight high lending fee stocks, underperform, and charge lower management fees than non-lending funds; lending fees negatively predict future fee-exclusive and fee-inclusive stock returns; and conditions affecting lending markets often have no effect on equilibrium share prices.
Keywords: Share lending, short selling, mutual funds, ETFs, incentives, asset management
JEL Classification: G11, G12, G23
Suggested Citation: Suggested Citation