Passive Asset Management, Securities Lending and Stock Prices

Abstract

How does the shift to passive investments affect securities prices? We propose and analyze a security lending channel in which passive funds serve as primary providers of lendable shares to make short selling possible. We show that stocks with high level of passive ownership exhibit greater supply of lendable shares which results in larger short positions, lower lending fees and longer durations of security loans. The effect of passive investors on security lending is significantly larger than the effect of other lenders such as actively managed funds and other institutional asset managers. Consistent with the literature on short-sale constraints, we find that constrained stocks with more passive ownership exhibit lower cross-autocorrelations with negative market returns and more negative skewness in stock returns. To mitigate identification concerns, we confirm our main findings using Russell index reconstitution that generates quasi-random variation in passive ownership. Our study suggests that passive investors make market prices more efficient by relaxing short-sale constraints.

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

JEL Classification: G12, G14, G23