Session Chair: Pasquale Della Corte, Imperial College Business School
Short Selling ETFs
Weikai Li1, Qifei Zhu2
1Singapore Management University; 2University of Texas at Austin
Discussant(s): Melissa Porras Prado (Nova School of Business and Economics)
We provide novel evidence that arbitrageurs use exchange-traded funds (ETFs) as an avenue to circumvent short-sale constraints at the stock level. Using a large sample of U.S. equity ETF holdings, we document that shorting activity on ETFs rises with the difficulty of shorting the underlying stocks. Stocks that are heavily shorted via their holding ETFs underperform those lightly shorted by 94 basis points per month. The return predictability of ETF short selling on individual stocks is distinct from stock-level shorting measures, and is concentrated among stocks that face the most severe arbitrage constraints. Across a broad set of capital market anomalies, we find that anomaly returns are significantly attenuated when ETF ownership is high. Our evidence suggests that ETFs contribute to a more informationally efficient market by allowing arbitrageurs to target overpriced stocks that are otherwise difficult to short.
Do Institutional Incentives Distort Asset Prices?
London Business School
Discussant(s): Michael Halling (Stockholm School of Economics)
The incentive contracts of delegated investment managers may have unintended negative consequences for asset prices. I show that managers who are compensated for relative performance optimally shift their portfolio weights towards those of the benchmark when volatility rises, putting downward price pressure on overweight stocks and upward pressure on underweight stocks. In quarters when volatility rises most (top quintile), a portfolio of aggregate-underweight minus aggregate-overweight stocks returns 3% to 8% per quarter depending on the risk adjustment. Prices rebound in the following quarter by similar amounts, suggesting that the changes are temporary distortions. Consistent with the growing influence of asset management in the US equity market, the distortions are stronger in the second half of the sample, while placebo tests on institutions without direct benchmarking incentives show no effect. My findings cannot be explained by fund flows and thus constitute a new channel for the price effects of institutional demand. The effects come into play precisely when market-wide uncertainty is rising and distortions are less tolerable, with implications for the real economy. Additionally, the paper offers novel evidence on a prominent class of models for which empirical investigations have been relatively scarce.
The Limits to (Short) Arbitrage
Matthew Ringgenberg1, Jesse Blocher2
1University of Utah; 2Vanderbilt University
Discussant(s): Guillaume Vuillemey (HEC Paris)
Theoretical models often assume short selling is costless. We show that short selling is expensive precisely when arbitrage opportunities are greatest. We examine the determinants of short constraints over time and find that 94% of overpricing exists in persistently constrained stocks, which inhibits short selling as a mechanism for price efficiency. Using the dynamic determinants of these short constraints, we then develop a novel measure which allows us to quantify these short constraints monthly in each stock from 1996 to present. Our results show that the dynamic properties of short sale constraints are a crucial component of the limits to short arbitrage.