Jesse Blocher and Matt Ringgenberg
Working Paper
Publication year: 2018

Historically, option market makers were exempt from borrowing shares when short selling which allowed them to hedge their exposure in hard-to-borrow stocks. As a result, options were not redundant securities — they allowed traders to circumvent short-sale constraints. Regulators removed this exemption in 2008 and in 2013 they prohibited a workaround using ‘reverse conversions’. These regulatory changes eliminated the shadow supply of hard-to-borrow shares provided by options; we find that these changes increased the redundancy of option securities and caused a significant increase in equity loan fees. Consequently, market quality has deteriorated: price efficiency is lower and stocks are more overpriced.

  • Thanks for helpful comments from Rich Evans, Adam Reed, Ngoc-Khanh Tran, and Karl Diether.
  • Thanks to brown bag participants at Vanderbilt University, Georgia Tech, and Syracuse University.
  • Thanks to conference participants at the Conference on Financial Regulation at the Federal Reserve Bank of Atlanta (2017).
  • Presented at the Mid Atlantic Research Conference at Villanova in March, 2018.
  • Presented at the SFS Cavalcade at Yale in May 2018.
  • Presented at the Western Finance Association conference in Coronado, CA in June 2018.

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