Does Passive Investing Help Relax Short-Sale Constraints?

Abstract

Prior literature argues that passive investing mainly introduces price inefficiencies. This article presents a channel through which passive investing leads to more informative prices. We study the impact of passive investors’ security lending on short-sale constraints. Stocks with higher passive ownership exhibit larger short positions, lower lending fees and longer loan durations. This effect is significantly larger for passive than for active investors. Higher passive ownership is associated with lower cross-autocorrelations with negative market returns, less skewness, and a smaller value premium, especially among hard-to-borrow stocks. These results suggest that passive investing contributes to price efficiency by relaxing short-sale constraints.

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

JEL Classification: G12, G14, G23