Working Paper: CEPR ID: DP17099
Authors: Julien Hugonnier; Rodolfo Prieto; Theodoros Evgeniou
Abstract: We study a dynamic equilibrium model with costly-to-short stocks and heteroge- neous beliefs. The closed-form solution to the model shows that costly short sales drive a wedge between the valuation of assets that promise identical cash flows but are subject to different trading arrangements. Specifically, we show that the price of an asset is given by the risk-adjusted present value of future cash flows which include both dividends and an endogenous lending yield. This formula implies that returns satisfy a modified capital asset pricing model and sheds light on recent findings about the explanatory power of lending fees in the cross-section of returns. In particular, we show that once returns are appropriately adjusted for lending fees, stocks with low and high shorting costs offer similar risk-return tradeoffs.
Keywords: shorting costs; securities lending; heterogeneous beliefs; dynamic equilibrium
JEL Codes: D51; D52; G11; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| costly short sales (G19) | asset valuation (G32) |
| costly short sales (G19) | pricing dynamics (D49) |
| lending fees (G21) | cross-section of returns (G12) |
| adjustment for lending fees (G21) | observed returns (G17) |
| shorting costs (G19) | asset pricing dynamics (G19) |
| high shorting costs (G19) | lower average excess returns (G19) |
| lending fees (G21) | asset pricing outcomes (G19) |