Strategic Borrowing from Passive Investors: Implications for Security Lending and Price Efficiency

Abstract

We examine the effects of passive investing on security lending outcomes and price efficiency for the 2007-2017 period. These effects cannot be fully explained by the standard lending supply channel. While all institutional investors contribute to lending supply, only passive ownership improves price efficiency. Additionally, increased passive ownership correlates with higher lending fees and higher short interest. We propose a complementary, demand-based strategic borrowing channel wherein short-sellers prefer to borrow from passive investors to reduce dynamic short-selling risks. Consistent with our hypotheses, increased passive ownership is associated with lower fee, recall, and information leakage risks, and longer loan duration.

Keywords: Security Lending, Short-Sales Constraints, Passive Asset Management, Market Efficiency

JEL Classification: G12, G14, G23