Is There a Risk Premium in the Stock Lending Market? Evidence from Equity Options

Abstract

A recent literature suggests that uncertainty about future stock lending fees is an impediment to short-selling and this risk explains part of the returns to shorting. However, an investor can use the option market to establish a synthetic short position that embeds a fixed lending fee and avoids exposure to lending fee risk. This option-implied lending fee can be computed from a pair of option prices. For each set of options, the difference between the option-implied fee and the average realized lending fee during the life of the option is an estimate of the risk premium for bearing lending fee risk. We find that the average of these estimates is approximately zero, and therefore, the equity lending market does not exhibit a substantial risk premium. In addition, the option implied lending fee predicts future realized lending fees and stock returns better than actual lending fees. When we include both the option-implied lending fee and the implied volatility spread and skew in predictive regressions the option-implied lending fee predicts stock returns, but implied volatility spread and skew do not.