A Multiple Lender Approach to Understanding Supply and Search in the Equity Lending Market
Adam C. Kolasinski, University of Washington
Adam V. Reed, University of North Carolina
Matthew C. Ringgenberg, University of North Carolina

Although a large body of research has investigated the effects of short sale constraints, very little is understood about the origin of these constraints in the one-trillion-dollar equity lending market. Using a unique database comprising data from twelve lenders, we find significant dispersion in share loan fees across lenders, and we find that the dispersion is increasing in share loan demand and various proxies for search costs, including a stock’s illiquidity and the number of small lenders making loans. These findings are consistent with the existence of search frictions between share borrowers and lenders, as Duffie, Garleanu, and Pedersen (2002) suggest. We further analyze the effect of search frictions by examining the response of shorting cost to exogenous shocks in demand. We find that for stocks with moderate demand, loan fees are largely insensitive to demand shocks. However, for stocks with high demand, an increase in demand triples the already higher abnormal loan fees. Our findings help reconcile seemingly conflicting findings in the literature regarding the existence of both small and large effects of shifts in demand on price. We highlight the importance of search costs by showing that the various parameters in firms’ share loan supply schedules are closely related to cross-sectional differences in search costs. We conclude that short sale constraints could be slackened by the reintroduction of a central clearinghouse of share loans, which would reduce search costs.

Equity lending market efficiency is a primary determinant of investment performance for managers who borrow or lend stocks. This results of this research project help identify the determinants of lending fees. The results show that the fees depend on search costs, which suggests that central clearing could substantially increase the efficiency of this market.