We analyze a framework for understanding the impact of the equity lending market on share prices. Using very few assumptions, we show that the effect of shocks to the supply or demand for share ownership, the fraction of shares made available to short sellers by shareholders, short sale regulations, and disagreement among investors depends critically on whether a stock is hard to borrow or freely available. Empiricists analyzing the effect of these shocks or short sale regulations will find that an effect exists largely among hard to borrow stocks. We confirm empirically these equilibrium predictions. For example, we find that when shares are removed from the equity lending market around dividend dates (due to tax considerations), prices of stocks on special increase 1.1%. Those prices then return to pre-dividend levels as shares are again made available to shorts.
Presented at The Western Finance Association Meetings in Santa Fe, 2011 and seminars at the University of North Carolina – Chapel Hill and George Mason University.
We also thank Jennifer Conrad, Amy Edwards, Mike Ferri, Paolo Fulghieri, Diego Garcia, Charles Jones, Stewart Mayhew, Alex Philipov, Matt Ringgenberg, Fei Xie, Xiaoyan Zhang, and especially Karl Diether for helpful comments.