Stock Lending Research Articles

Under the Hood of Activist Fraud Campaigns: Private Information Quality, Disclosure Incentives, and Stock Lending Dynamics

ABSTRACT Although activist short sellers can play a crucial role in fraud detection, they have come under scrutiny following accusations of systematically disseminating false negative information. We develop a framework delineating the roles of campaign-specific private information quality and short-selling dynamics in shaping disclosure incentives. We predict that the act of disclosure combined with pre-disclosure stock lending dynamics is informative about the quality of an activist’s private information. We find that increased pre-disclosure shorting intensity is associated with more negative post-disclosure returns, adverse media coverage, and consequential campaign outcomes, including auditor turnover, accounting restatements, class-action lawsuits, and performance-related delistings. Furthermore, elevated short-selling costs and risks magnify the association between pre-disclosure shorting intensity and post-disclosure underperformance. Finally, we examine V-shaped reversals and short covering following activists’ disclosures and find no evidence of systematic manipulation. We conclude that activists disclosing fraud allegations under their own names are discouraged from engaging in “short-and-distort” schemes. Data Availability: Data are available from the sources cited in the text. JEL Classifications: G12; G14; G23; M41.

Under the Hood of Activist Fraud Campaigns: Private Information Quality, Disclosure Incentives and Stock Lending Dynamics

Under the Hood of Activist Fraud Campaigns: Private Information Quality, Disclosure Incentives and Stock Lending Dynamics

공매도 및 주식대차거래와 관련한 소득 과세

[Purpose]In this study, we examined the issues surrounding income taxation in relation to short selling and the stock lending transactions associated with it. Additionally, we proposed essential supplementary institutional measures. [Methodology]To achieve this, we scrutinized relevant precedents and interpretations in Korea, and consulted discussions and legislation in the United States and Japan. [Findings]The topics addressed in this study, along with the proposed measures for income taxation purposes, can be summarized in the following two points. [Implications]Firstly, during stock lending transactions, a formal transfer of ownership occurs. A question arises as to whether capital gains should be taxed following such a formal transfer of ownership. While administrative interpretation asserts no taxation, judicial precedent stipulates that transfer tax is imposed upon the transfer of legal ownership. In cases of qualified loan transactions where economic risks and rewards are not transferred, it is economically prudent not to tax capital gains, even if formal ownership is transferred. A similar issue existed in the United States and was resolved through legislation. Secondly, there is the matter of taxing investors on gains and losses from short selling. Under Korea’s income tax law, which adopts an enumerative method, gains and losses from short selling are not subject to taxation. Moreover, it is not included in the financial investment income tax, scheduled for implementation from 2025 following a postponement. Legislative supplementation is necessary, and given that short selling differs from spot investment in stocks and shares similar characteristics with stock derivatives, it seems fitting to categorize it under the basic deduction group of 2.5 million won. In short selling, when borrowed stocks are returned and the short selling is concluded according to the open transaction doctrine, gains and losses are confirmed, and the time for taxation arrives.

Overcoming Arbitrage Limits: Option Trading and Momentum Returns

AbstractMomentum profits depend mainly on the short leg and therefore on barriers to short sales. Our research indicates that the decline in momentum profitability in the past 2 decades is driven partly by a contemporaneous growth in stock options trading. Stock options offer an alternative to short selling, augmenting the stock lending market, and thereby contributing to improved pricing efficiency. The resulting reduction in barriers to short sales contributes to lower returns to momentum trading from the short leg. Our results persist after matching stocks with and without options based on different firm-level characteristics.

Counteracting large-scale asset purchase program: The Bank of Japan’s ETF purchases and securities lending

This study investigates the impact of the Bank of Japan’s (BOJ) exchange traded fund (ETF) purchasing program on the stock lending market. In particular, we focus on the fact that stocks held by ETF managers for the BOJ are lendable to other investors in order for them to make a short position in stock market. Using individual stock level data, we show that expansions of the ETF purchase program have substantially increased the supply of stocks in the lending market by changing the behavior of stock holders as the BOJ is expected to be a “buy-and-hold” type of investor. This result implies that such an active stock lending market would help to reduce the side-effects of the ETF program whereas the squeezing effect of the program on supply–demand balance in spot stock markets is mitigated.

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

ABSTRACTRecent research argues that uncertainty about future stock borrowing fees hinders short‐selling, and this risk explains the performance of short strategies. One possible mechanism is that borrowing fee risk carries a risk premium. Since the present value of the uncertain borrowing fee is reflected in options prices, the difference between option‐implied and realized fees estimates this premium. We find that the risk premium is small. Moreover, if the risk premium is substantial, it should be reflected in the returns to short‐selling stock after adjusting for stock borrowing fees. However, borrowing fee risk does not predict fee‐adjusted returns.

Stock lending and short-selling: evidence from national pension service in Korea

The National Pension Service (NPS) of Korea suddenly announced that they would suspend their stock lending business from October 22, 2018. Using this ideal setting, the authors investigate the effects of this suspension on market quality and short-selling activities. The authors find that stock return does not increase after the suspension of stock lending for both the KOSPI and KOSDAQ markets. However, the returns of stocks with NPS ownership decline less than those without NPS ownership. The authors also find that the institutional and foreign investors' short sales did not increase in both markets after the lending business suspension by the NPS. In addition, the effect of suspension of stock lending on market quality is mixed, so the authors cannot conclude that market quality has improved. Overall, the authors’ results indicate that the stock market, especially for short-sales activity, has not been affected by the suspension of the stock lending service by the NPS.

Counteracting Large-Scale Asset Purchase Program: The Bank of Japan's ETF Purchases and Securities Lending

This study investigates the impact of the Bank of Japan’s (BOJ) exchange traded fund (ETF) purchasing program on the stock lending market. In particular, we focus on the fact that stocks held by ETF managers for the BOJ are lendable to other investors in order for them to make a short position in stock market. Using individual stock level data, we show that expansions of the ETF purchase program have substantially increased the supply of stocks in the lending market by changing the behavior of stock holders as the BOJ is expected to be a “buy-and-hold” type of investor. This result implies that such an active stock lending market would help to reduce the side-effects of the ETF program whereas the squeezing effect of the program on supply-demand balance in spot stock markets is mitigated.

Supply Constraints and Limits to Arbitrage in the ETF Loan Market

We find that exchange-traded fund (ETF) lending fees are significantly higher than stock lending fees. Two institutional features unique to ETFs play significant roles in explaining the high fees. First, regulations restrict investment companies, such as mutual funds and ETFs, from owning ETFs. As these institutions are key lenders, their absence reduces the lendable supply in the ETF loan market. Second, while the create-to-lend (CTL) mechanism alleviates supply constraints when borrowing demand increases, its efficacy is limited by the associated costs and frictions. Our results speak to the limits to arbitrage in the ETF markets.

Gamestonk: What Happened and What to Do about It

The price of GameStop stock exploded from $18.84 at the end of 2020 to a high of $483 on January 28, 2021, before collapsing to under $60 in early February. The stock had long been heavily shorted even before the pandemic. A stock bubble and its collapse inflict collateral damage even on those not participating in the bubble, including index-fund investors. The incident raises questions about the duties of brokers and financial service professionals in the age of social media, and the role of payment for order flow (PFOF). The price dislocation in GameStop highlights several leaks in the plumbing of the US equity market that need to be plugged or else similar dislocations will happen again. The antiquated T+2 settlement cycle needs to be shortened to reduce risk and attendant collateral needs in the system. Institutional short positions should be disclosed on SEC Form 13F just as long positions are. The frequency of short interest disclosure should be increased to daily from the current biweekly. The SEC should implement the Congressional mandate in Dodd-Frank §894 to increase transparency in the stock lending market by implementing a ticker tape for stock lending transactions. Short positions should be marked to market yearly for tax purposes yearly to eliminate the tax incentive to delay covering short positions. SEC rules 204 and 15c3-3 need to be modernized to help prevent spikes in prices far beyond any reasonable levels. Rule 606 should be extended to require brokers to report retail execution quality.

Who is buying and (not) lending when shorts are selling?

Stock lending markets are unique because stock buyers become potential stock lenders. During periods of high short demand, loan supply should expand as some new buyers of loaned shares lend them. Using instrumental variables, we find instead that loan supply contracts: during times of high short demand, the marginal buyer lends stock at a lower rate than the average seller. We find that this puzzling result is concentrated among closely held stocks with high disagreement among investors, high price impact measures, and lottery-like returns. Thus, non-lending buyers may believe that withholding shares from short sellers could enhance their expected returns.

The role of lender country factors in cross border bank lending

This article considers the cross-border lending stock from 19 advanced countries to European countries using quarterly data for 1999–2016. An extended model based on home and host country characteristics conditioned on distance and mass primarily measured by GDP is used to explain the behaviour of cross-border lending stocks. We focus particularly on the competitive structure of domestic banking markets and on the role of EU integration using indicators from the New Industrial Economics literature. Our results suggest EU integration has had a large effect on cross-border lending, although this has been partly reversed after Euro debt crisis. This reversal probably arises more from the actions of home country bank regulators rather than from the rise in risk premia in host countries. We show that in general lender rather than borrower factors are more important, and that more concentrated or less competitive lender countries do more cross border lending, especially in less concentrated or more competitive borrowers. Our results are robust across a range of specifications.

The short-selling skill of institutions and individuals

Abstract Using market-wide data from the Brazilian stock lending market at the deal level, we find strong evidence of short-selling skill for institutions and individuals. Skilled short-sellers present out-of-sample performance persistence. Exploring the granularity of our dataset, we find that skilled short-sellers do not display the disposition effect, are more likely to pick value, liquid, high-volatility, and losing stocks, and to initiate a short position before earnings announcements and around sell recommendations.

Funding Adjustments in Equity Linear Products

Valuation adjustments are nowadays a common practice to include credit and liquidity effects in option pricing. Funding costs arising from collateral procedures, hedging strategies and taxes are added to option prices to take into account the production cost of financial contracts so that a profitability analysis can be reliably assessed. In particular, when dealing with linear products, we need a precise evaluation of such contributions since bid-ask spreads may be very tight. In this paper we start from a general pricing framework inclusive of valuation adjustments to derive simple evaluation formulae for the relevant case of total return equity swaps when stock lending and borrowing is adopted as hedging strategy.

An analysis of over-the-counter and centralized stock lending markets

We provide new insights about centralized and OTC stock lending in the context of Tokyo Stock Exchange listed stocks from July 2006 to December 2009. We find that not only the demand drivers in the two markets are significantly different but also the pricing efficiency implications of the alternative markets are different. Specifically, we find that higher OTC stock lending activity is associated with greater pricing efficiency and better liquidity. The benefits of the centralized market on average is less clear, but when the OTC market is constrained, it is shown to relax short-sale constraints and improve liquidity.

Overcoming Arbitrage Limits: Option Trading and Momentum Returns

We find that the decline in momentum profitability is partly driven by option trading. Momentum profits arise from the short leg and therefore on barriers to short selling. We find strong evidence that the presence of stock options creates alternate avenues for short selling, augmenting the stock lending market, thus contributing to improved pricing efficiency. However, when options trading becomes expensive, the short position offers lower returns. We find that our results remain unchanged when we match the universe of stocks with and without options based on variables that determine the eligibility of a stock to be optionable, indicating that firm-level characteristics cannot account for the significant differences in the profitability of the two strategies.

Short Sale Constraints and Single Stock Futures Introductions

AbstractThis paper exploits the unique experimental setting created by nearly 1,300 new single stock futures listings on the OneChicago exchange between 2003 and 2009. I investigate the impact of derivatives introductions on the tightness of short sale constraints facing their underlying assets. After controlling explicitly for supply and demand conditions in the stock lending market, this experiment reveals a precipitous decline in active utilization rates and loan fees in the lending market, after the futures introductions. The paper provides strong evidence that supports the view that derivatives represent a viable alternate synthetic short selling venue relaxing short sale constraints facing their underlying assets.

Can the Market Divide and Multiply? A Case of 807 Percent Mispricing in Absence of Arbitrage Risk

This paper documents a strong violation of the law of one price surrounding a large rights issue. If prices are right, the relation between the prices of shares and rights follows the outcome of a simple calculation. In the case of Royal Imtech N.V. in 2014, prices deviated sharply and persistently from the theoretical prediction. Throughout the term of the rights, investors were buying shares at prices that were many times what they should have been given the price of the rights. Short-selling constraints in the form of high recall risk and lacking stock lending supply are the most likely explanation for the failure of arbitrage as a safeguard of market efficiency. Still, it remains remarkable that investors were buying large volumes of shares at highly inflated prices in the presence of a cheap, perfect substitute.

A Comparative Study on the Information Effect of Stock Lending and Borrowing and Short Selling between the Korea Stock Exchange and the New Stock Exchange

The purpose of this study is to compare the information effect of Stock Lending and Borrowing (SLB) and short selling between the Korea Stock Exchange (KRX) and the New York Stock Exchange (NYSE). While most previous studies analyzed the information effect with a focus on short selling, this study links short selling to SLB and examines how SLB and short selling affect stock prices. Using the data of 40 stocks with the most active records of SLB and short selling from each exchange, we perform a regression analysis to examine the information effect. We find that in the KRX, SLB has a positive effect on short selling and short selling has a negative effect on stock prices. However, in the NYSE, short selling has a significant positive effect on stock prices. This is due to the differences in policies concerning public posting of short selling data. We also find that the effect of volatility on stock prices and the effect of short selling on volatility are all significantly negative in both exchanges. That is, short selling reduces market volatility and thus keeps the market from overheating. Furthermore, the effects are greater during the periods when SLB and short selling are more concentrated.

Are Shorts Equally Informed? A Global Perspective

Using a daily sample of 25 countries from 2006 to 2010, we examine whether information from shorts can significantly predict future stock returns across different countries. We construct seven shorting measures using past shorting transactions, and fees information in the lending market. The majority of our shorting measures significantly predict future stock returns. Interestingly, the relative importance of these variables varies substantially across countries. We explain the cross-country differences with variations in regulations on short selling, market quality and country development measures. The recent naked short sale bans strengthen the informativeness of shorting. The presence of a centralized stock lending market and low liquidity weaken the return predictability of short selling. In addition, higher country GDP per-capita, as well as country market openness, enhances short sales’ informativeness.