Dynamic Equilibrium with Costly Short-Selling and Lending Market

53 Pages Posted: 3 Feb 2020

See all articles by Adem Atmaz

Adem Atmaz

Purdue University - Krannert School of Management

Suleyman Basak

London Business School; Centre for Economic Policy Research (CEPR)

Fangcheng Ruan

Purdue University - Krannert School of Management

Date Written: December 9, 2019

Abstract

We develop a tractable model of costly stock short-selling and lending market within a familiar dynamic asset pricing framework. The model addresses the vast empirical literature in this market and generates implications that support many of the empirical regularities. In the model, investors’ belief disagreement leads to the presence of stock lenders and short-sellers, who in turn pay shorting fees to lenders. We find that the equilibrium stock price increases in shorting fee, and both the stock price and shorting fee decrease in lenders’ size. We additionally show that the stock risk premium decreases in shorting fee, while the stock volatility is increased due to costly short-selling. Notably, we demonstrate that the equilibrium short interest increases in shorting fee and predicts future stock returns negatively. Furthermore, we find that short-selling risk matters in equilibrium, and show that a higher short-selling risk can lead to lower stock returns and less short-selling activity.

Keywords: short-selling, stock lending, belief disagreement, shorting fee, short interest, stock price, stock risk premium, volatility, short-selling risk, short-selling activity

JEL Classification: G11, G12

Suggested Citation

Atmaz, Adem and Basak, Suleyman and Ruan, Fangcheng, Dynamic Equilibrium with Costly Short-Selling and Lending Market (December 9, 2019). Available at SSRN: https://ssrn.com/abstract=3516969 or http://dx.doi.org/10.2139/ssrn.3516969

Adem Atmaz (Contact Author)

Purdue University - Krannert School of Management ( email )

403 West State Street
West Lafayette, IN 47907
United States

HOME PAGE: http://www.aatmaz.com

Suleyman Basak

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
44 (0)20 7000 8256 (Phone)
44 (0)20 7000 8201 (Fax)

HOME PAGE: http://www.suleymanbasak.com

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Fangcheng Ruan

Purdue University - Krannert School of Management ( email )

1310 Krannert Building
West Lafayette, IN 47907-1310
United States

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