Market Power in the Securities Lending Market
94 Pages Posted: 10 May 2022 Last revised: 12 Jul 2023
Date Written: May 4, 2022
We document the presence of market power in the equity securities lending market and evaluate its impact on different investor groups and valuations. Our analysis reveals high market concentration, non-competitive fees, and low inventory utilization in the cross-section of stocks. Motivated by this evidence, we develop and estimate a dynamic asymmetric-information model that sheds light on the benefits of this current market structure for both security lenders and short sellers. We find that lending fee income raises shares lenders’ equity valuations by 1.5% for large-cap, low-fee stocks, by up to 25% for small-cap stocks, and by even more than 100% for nano-cap stocks. Our model yields estimates of the distribution of alphas from shorting different segments of the cross-section of stocks, indicating that fees reduce short sellers’ profits by about 60%.
Keywords: Short selling, market power, custodian lenders
JEL Classification: G12, G23
Suggested Citation: Suggested Citation