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

Abstract

We hypothesize that short-sellers strategically borrow shares from passive investors to reduce dynamic short-selling risks. This behavior drives up lending demand for stocks with high passive ownership, conditional on ownership by other investors. Consistent with our hypothesis, these stocks have better price efficiency, higher lending fees and higher short interest. They also exhibit lower risks of unexpected fee increases and loan recall, have longer loan durations, and attract better-informed short-sellers. These results are concentrated in hard-to-borrow stocks where short sale constraints are likely to bind. Our findings suggest that passive investing relaxes short-sale constraints by making borrowing shares less risky.

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

JEL Classification: G12, G14, G23