Thread by @ReformedTrader

1/ Short-Selling Risk (Engelberg, Reed, Ringgenberg)

"Short sellers face unique risks, such as the risk that stock loans become expensive or are recalled. Stocks with more short-selling risk have lower returns, less price efficiency, less short selling."

papers.ssrn.com/sol3/papers.cf…

2/ "We calculate the ln of the variance of the daily Loan Fee for each stock over the past 12 months, then project this variable on a variety of lagged firm and lending market characteristics. The predicted value (ShortRisk) represents a trader’s estimate of short-selling risk."

3/ "Short-selling risk is lower for stocks with traded options and higher immediately following an IPO and for stocks with a large number of failures in the securities lending market.

"We use the predicted value from this model as a forecast of short-selling risk."

4/ "Overall, our findings suggest that higher short-selling risk is a significant limit to arbitrage.

"To start, we form simple portfolios formed by conditioning on our risk measures.

"Figure 1 shows a close connection between short-selling risk and future returns."

5/ "A strategy that buys stocks with low ShortRisk and shorts stocks with high ShortRisk earns positive and statistically significant long-short portfolio returns in each of the five short interest quintiles."

6/ "Table IV repeats the portfolio exercise with FF five-factor alphas.

"Table IV, as with Table III, is consistent with models of limits to arbitrage: we find that the returns to short selling are largest when arbitrage is riskiest."

7/ "The fact that our results are strongest among Micro/Small stocks is not surprising: there is less short-selling risk for Large stocks.

"The 99th of loan fees in the Micro (Large) sample is 1,119 (236) bps. The 90th percentile is 189 (20) bps for Micro (Large) stocks."

8/ "The negative and statistically significant coefficient on ShortRisk is consistent with the hypothesis that short-selling risk is a significant limit to arbitrage.... even after controlling for current short sale constraints and other known predictors of returns."

9/ "The risk of *future* short-selling constraints is associated with decreased price efficiency *today*, independent of short constraints that may exist at the time a short position is initiated."

10/ "Put-call parity is more likely to be violated when short-selling risk is high.

"The impact of ShortRisk increases for options with more time to expiration.

"Short sellers also trade less when short-selling risk is high; this is compounded by long holding horizons."

11/ "Loan fees increase significantly when past returns are in either the highest or the lowest quartile of returns.

"When a short seller’s position moves against her, it is likely that it will also be more difficult to borrow shares in the equity lending market."

12/ "Firms in the bottom (top) decile of past 20-day returns have loan fees that are 13 (10) bps higher. This is large compared to the unconditional mean (median) fee of 85 bps (11 bps).

"(2) and (4) include firm fixed effects so that the coefficients are estimated within-firm."

13/ Related research:

Why Do Price and Volatility Information from the Options Market Predict Stock Returns?

https://twitter.com/ReformedTrader/status/1332175279842725891

The Loan Fee Anomaly: A Short Seller's Best Ideas

https://twitter.com/ReformedTrader/status/1324519224279064576

Borrowing Fees and Expected Stock Returns

https://twitter.com/ReformedTrader/status/1328467331916316674