No full-text available
To read the full-text of this research,
you can request a copy directly from the author.
Strategic Delivery Failures in U.S. Equity Markets. Journal of Financial Markets, 9, 1-26
Abstract
Sellers of U.S. equities who have not provided shares by the third day after the transaction are said to have “failed-to-deliver” shares. Using a unique data set of the entire cross-section of U.S. equities, we document the pervasiveness of delivery failures and evidence consistent with the hypothesis that market makers strategically fail to deliver shares when borrowing costs are high. We then show that many firms that allow others to fail to deliver to them are themselves responsible for fails-to-deliver in other stocks. Finally, we discuss the implications of these findings for short-sale constraints, short interest, liquidity, and options listings in the context of the recently adopted SEC Regulation SHO.
... The security borrowing costs involved normally approximate the risk-free rate of interest, although those expenses have been found to be much higher in some cases (Jones and Lamont, 2002). However, many investors circumvent those costs by selling stock short without ever delivering the shares to the buyers in a process called naked shorting that has long been quite rampant because the security clearing agents generally don't enforce delivery requirements on short positions (Boni, 2006). Evans, Musto, and Reed (2009) have found that naked short sales are highest on stocks that are more difficult and costly to borrow, and such sales that minimize the costs of pressuring down market values may negatively impact capital raising activities. ...
... The failure to deliver shares against short positions could have an informational impact since the resulting naked positions theoretically imply a requirement for delivery later that mightraise the cost of borrowing shares in the future associated with taking or holding short positions, possibly even creating a risk of the rapidly rising prices associated with a short squeeze. In fact, the SHO regulations that were created by the SEC in 2004, that went into effect on Jan. 3,2005, and that require disclose of information on extensive failures to deliver shares on stock sales within the mandatory 3 days were designed for that purpose (Boni, 2006). ...
... level. 9 These findings are consistent with a hypothesis that naked short positions do negatively affect the capacity of firms to raise external capital, with the extent of the adverse impact being related to the size of the funding need. ...
This research finds some empirical evidence that the sale of stock without delivering shares can contribute to pressuring down the equity prices of companies seeking to raise capital. By allowing for the delayed effects on prices of limit orders by naked shorts, a significant negative impact on equity value per share is discovered but only for naked short selling by market makers and only on stocks of firms in urgent need of external financing.
... Using data from October 2004 to March 2005 (6 months surrounding Rule 203 implementation), we find significant increases in the trading volumes of call and put options after the implementation of Rule 203. Specifically, we find a 13.2 % (21.8 %) 3 The fail-to-deliver typically occurs three business days after the naked short sale due to the "T+3" settlement used in the US Boni (2006) finds that prior to Regulation SHO, a substantial fraction of issues (42 % of listed stocks and 47 % of unlisted stocks) had persistent fails-to-deliver of five days or more and these long-lived cases of "fail-to-deliver" were more likely to occur when stocks were expensive to borrow. This is consistent with the fact that equity and options market makers strategically fail to deliver shares that are expensive or impossible to borrow (Evans et al. 2009). ...
... In such cases, naked short selling, then failing to deliver is economically equivalent to borrowing shares at a zero-fee, zero-rebate equity loan plus the expected cost of being forced to buy back the stock and deliver it (a process called "buying-in"). As shown in Boni (2006) and Evans et al. (2009), the probability of buying-in is quite low. Therefore, if equity loans are expensive, unavailable or unreliable, as research shows they can be (e.g., D'Avolio 2002; Geczy et al. 2002;Jones and Lamont 2002;Lamont 2012), naked short selling and then failing to deliver is less costly than covered short selling. ...
... 13 128/588 is 21.8 %, where 588 is the mean value of daily put options volume in the 3-month period before the implementation of Rule 203. 14 Boni (2006) documents that the likelihood of persistent fails-to-deliver (a proxy for naked short selling) decreases with institutional ownership. Institutional ownership is defined as institutional holdings divided by the total number of outstanding at the last quarter end. ...
In this study, we investigate the effects of stock short-sale constraints on options trading by exploiting two US Securities and Exchange Commission rule changes under Regulation SHO: Rule 203 (locate and close-out requirements) and Rule 202T (temporary removal of short-sale price tests). We find that stock short selling activities decrease (increase) significantly after Rule 203 (Rule 202T) implementation, supporting the validity of Rule 203 (Rule 202T) as an exogenous increase (decrease) in short-sale constraints. Options volume increases significantly after Rule 203 went into effect and the result is more pronounced among firms with lower levels of institutional ownership and smaller options bid-ask spreads. Therefore, the evidence from Rule 203 suggests that investors may use options as substitutes for stock short sales when short selling is less feasible or more costly due to the locate and delivery requirements. In contrast, we find no significant change in the options trading volume of pilot stocks during the pilot program of Rule 202T. Overall, our results indicate that the impact of short-sale constraints on options trading varies with the types of constraints affected.
... Our paper is not the first to look at the issue of fails-to-deliver in equity markets. 9 Boni (2006) investigates the fail-to-deliver issue using fails data for three settlement days prior to the implementation of Regulation SHO. She finds evidence that persistent fails-to-deliver, and, hence, persistent fails-toreceive , are strategic decisions of market participants to establish goodwill. ...
... Hypothesis 1 is based on the premise that the short seller wishes to make delivery on the settlement date, but is prevented from doing so by a lack of stock to borrow. Hence, a showing of sufficient stock offered 12 We use the same definition of 'persistent' fails as Boni (2006). for lending on the settlement date is sufficient to refute the hypothesis. ...
... These considerations lead to the following hypothesis: Hypothesis 3: Fails-to-deliver are the result of a fail-to-borrow available shares. Evans et al., (2009) and Boni (2006) show that fails-to-deliver are linked to the cost of borrowing, with failures increasing in borrowing costs. Our analysis differs. ...
We investigate the impact of failures-to-deliver on the performance of 116 Real Estate Investment Trusts (REITs) during a period of substantial short selling (calendar years 2007 and 2008). REIT shares typically are easy to borrow, have high transparency (low information asymmetry), and are exposed to systematic risk during the sample period, making them short sale targets. We find that the majority of failure-to-deliver events are quickly resolved, with durations of less than three days. Our results support the conjecture that most failures-to-deliver result from short sellers covering their trades before the settlement date of the initial sale. Since the failure is resolved when the covering purchase settlement day arrives, traders forego borrowing which results in a failure-to-deliver. However, failures-to-deliver that are outstanding for many days have lower risk adjusted returns. Our results support the actions taken by the SEC in September of 2008 to tighten the delivery requirement of stock trades.
... Many brokerdealers severely restrict short selling by their retail customers. However, the SEC has expressed concern that enforcement of the restrictions on short selling, and especially naked short selling, appears lax due to broker-dealers' tolerance of extended fails to deliver (SEC, 2003b, Boni, 2004. ...
... activities (SEC, 2003b(SEC, , 2004, which provides a potential loophole. 20 Boni (2004) finds that naked short sales are pervasive in the U.S. stock market, which supports the SEC's concern that broker-dealers have not been diligent in enforcing the existing short sale restrictions. 21 ...
... However, term stock loans are unusual, and they are expensive (Geczy et al., 2002). Instead, market participants may use strategic fails to deliver (i.e., naked shorting) when stock borrowing is costly or impossible (Evans et al., 2003, Boni, 2004. ...
The SEC recently adopted Regulation SHO to tighten restrictions on short selling and curb abusive short sales, including naked shorting masquerading as routine fails to deliver. This paper models market equilibrium when short selling is permitted and contrasts the equilibrium with and without manipulators among the short sellers. I explain how naked short selling can routinely occur within the securities clearing system in the United States and characterize its potentially severe market impact. I show how a recent securities innovation called floating-price convertible securities can resolve the unraveling problem and enable manipulative short selling to intensify.
... Thus, shocks to any of these markets can affect many other areas of the financial system via their linkages to ETFs and the institutions that serve as ETF market makers. 11 For research on the FTDs of U.S. equities, see Boni (2006); Stratmann and Welborn (2013) ;Fotak, Raman, and Yadav (2014); Autore, Boulton, and Braga-Alves (2015); and Jain and Jain (2015). For FTDs in option markets and linkages to common stocks, see Evans, Geczy, Musto, and Reed (2009); Battalio and Schultz (2011);and Stratmann and Welborn (2013). ...
... Additionally, Boni (2006) shows that FTDs were pervasive and persistent in U.S. equities during three settlement dates: September 2003, November 2003, and January 2004. This finding is consistent with market makers' incentive to "strategically fail" when borrowing costs are high. ...
While ETFs constitute just under 10% of U.S. equity market capitalization, they account for over 20% of short interest and nearly 79% of failures-to-deliver in U.S. equities. While the disproportionate share of short activity in ETFs has raised concerns about excessive shorting and naked short-selling, we identify an alternative cause for this activity related to the market making activities associated with the ETF creation/redemption process, which we label “operational shorting.” We propose a simple methodology to estimate operational shorting and show that our measure is consistent with the economics behind the mechanism. In examining the market implications of operational shorting, we find that it is associated with improved ETF liquidity but that it is also predictive of market-wide indicators of systemic and counterparty risk. In exploring possible mechanisms for this predictive relationship, we find there is commonality in operational shorting across ETFs that have the same lead market maker/authorized participant and that market makers’ financial leverage might be a channel that amplifies this commonality, both of which are suggestive of an increase in counterparty risk.
... Our research connects the short sale constraint literature with emergent research on short sale regulation, naked short selling, and trade settlement. Boni (2006), Evans et al. (2009, and Stratmann and Welborn (2013) find that market makers strategically fail-to-deliver when stock borrow costs are high and settlement regimes are permissive. Culp and Heaton (2008) develop a theoretical model in which short selling and naked short selling are economically equivalent. ...
... Previous research has demonstrated a strong relationship between short sale demand, FTDs, and the options market when stock borrow costs are high (Boni, 2006; Evans et al., 2009, Welborn and Stratmann, 2013). When shortable stock is expensive or scarce, short sellers can trade options to create synthetic short positions that are economically equivalent to short sales. ...
We find that stocks with fails-to-deliver (FTDs) experience negative abnormal returns that are proportional to their FTD levels. These findings come from both an event study and a portfolio returns analysis using Fama-French factors. Using proprietary data on stock borrow costs, we also show that short sellers of low and high FTD stocks obtain positive estimated profits. Our findings support the hypothesis that FTDs reflect nonbinding short sale constraints which do not restrict informed short selling.
... l. (2005), and Kolasinski et al. (2013aprovide empirical support for the DV model.Beneish et al. (2015)find that short selling is most profitable in hard-to-borrow stocks with nonbinding constraints. Our research connects the short sale constraint literature with emergent research on short sale regulation, naked short selling, and trade settlement.Boni (2006), Evans et al. (2009, andStratmann and Welborn (2013)find that market makers strategically fail-to-deliver when stock borrow costs are high and settlement regimes are permissive. Culp and Heaton (2008) develop a theoretical model in which short selling and naked short selling are economically equivalent.Devos et al. (2010) andLecce et a ...
... Previous research has demonstrated a strong relationship between short sale demand, FTDs, and the options market when stock borrow costs are high (Boni, 2006;Evans et al., 2009, Welborn andStratmann, 2013). When shortable stock is expensive or scarce, short sellers can trade options to create synthetic short positions that are economically equivalent to short sales. ...
We find that stocks with high fails-to-deliver (FTDs) experience abnormal negative returns, both in present and future periods. These findings come from both an event study and a portfolio returns analysis using Fama-French factors. They are consistent with previous research documenting that high short interest stocks experience abnormal negative returns. Using proprietary data on stock borrow costs, we also show evidence that short sellers of high FTD stocks, on average, obtain economic profits from their trades. Our findings provide support for the hypothesis that high FTD levels reflect a nonbinding short sale constraint that does not restrict informed short selling.
... Further, some naked short-selling is due to market making. A fail to deliver (FTD) occurs when the seller of a security does not deliver that security to the buyer within the standard three-day settlement period (Boni, 2006). Naked short-selling is one way that this can occur. ...
... FTDs can also arise from various processing errors, delays in obtaining physical stock certificates or human error in entering the incorrect stock symbol. Boni (2006) provides an empirical description of delivery failures in US equity markets prior to Regulation SHO. The evidence is consistent with the hypothesis that pre-Regulation SHO, equity and options market-makers strategically failed to deliver shares that were expensive or impossible to borrow. ...
... Academic research on stock settlement failures has developed only recently. Boni (2006) and Evans et al. (2009) both examine the relationship between options market making and trade settlement. Boni (2006) uses pre-Regulation SHO FTD data from three dates in 2003 and 2004, a period without a formal close-out requirement, and finds evidence that short sale borrowing constraints may lead to ''strategic'' FTD in optionable stocks. ...
... Boni (2006) and Evans et al. (2009) both examine the relationship between options market making and trade settlement. Boni (2006) uses pre-Regulation SHO FTD data from three dates in 2003 and 2004, a period without a formal close-out requirement, and finds evidence that short sale borrowing constraints may lead to ''strategic'' FTD in optionable stocks. Evans et al. (2009) analyze the relationship between put-call parity and short sale borrow costs using data provided by an OMM from 1998 and 1999. ...
Until 2008, options market makers engaged in bona fide market making were exempt from locate and certain close out requirements for short sales (the “Exception”). This Exception applied only to short sales that qualified as bona fide hedges of options positions that were established before a stock went on the SEC Regulation SHO Threshold List. In this paper we examine the consequences of eliminating this close-out Exception. Specifically, we test the hypothesis that eliminating the Options Market Maker Exception to SEC Regulation SHO reduced the incentive to naked short sell stocks through the options market. We compare data from the second and fourth quarters of 2008. Consistent with our predictions, we find that eliminating the Exception led to fewer fails-to-deliver and higher stock borrow rates for optionable stocks as compared to non-optionable stocks. Further, removing the Exception reduced fails-to-deliver for optionable stocks when the price of borrowing stock was high. Finally, options market trading volume declined after the Exception was eliminated.
... Thirdly, this overview suggests an alternative to the reason put forward by Boni (2006) to explain why buy-ins are rare. Given the way in which the settlement procedures reallocate FTRs and the finding that FTDs represent approximately 1-5% of daily traded volume, only in rare circumstances or in very infrequently traded stocks would a participant have an FTR for long enough to initiate the Buy-in process, let alone complete it. ...
... ecause in the delivery process positions are netted and the NSCC assumes the role of counterparty to each transaction. Instead, it is the participant with the oldest fails that is forced to buy the stock.Buy-ins are rare.Evans et al. (2009) find that out of a total of 69,063 failed transactions of a market maker in 1998-1999 only 86 were bought-in.Boni (2006) argues that one reason why buy-ins are rare is that firms are unwilling to earn a reputation for forcing delivery in the hope that other firms will be equally lenient towards them when they fail to deliver. This overview of the clearing and settlement procedures suggests an alternative reason why buy-ins are rare. Multilateral netting i ...
This article outlines the process of clearing and settlement for stock trades in the US. It pays particular attention to what happens when the seller of a stock fails to deliver that stock at settlement and describes the mechanisms to resolve delivery failures. Fails to deliver can occur for a number of reasons, such as human error, administrative delays and the controversial practice of naked short selling. This article helps understand the implications of naked short selling for trade counterparties and, more generally, the effects of naked short selling on the clearing and settlement system.
... The security borrowing costs involved normally approximate the risk-free cost of borrowing, although those expenses have been found to be much higher in some cases (Jones and Lamont, 2002). However, many investors circumvent those costs by selling stock short without ever deliver the shares to the buyers in a process called naked shorting that is quite rampant because the security clearing agents generally don't enforce delivery requirements on short positions (Boni, 2006). Evans, Musto, and Reed (2009) have found that naked short sales are highest on stocks that are more difficult and costly to borrow. ...
... The failure to deliver shares against short positions could have an informational impact since the resulting naked positions theoretically imply a requirement for delivery later that could raise the cost of borrowing shares in the future and even create a risk of the rapidly rising prices associated with a short squeeze. In fact, the SHO regulations that were created by the SEC in 2004, that went into effect on Jan. 3, 2005, and that require disclose of information on extensive failures to deliver shares on stock sales within the mandatory 3 days were designed for that purpose (Boni, 2006). Several dummy variables are also included in the regression to enable factoring out the separate impacts that specific events may have had on stock returns. ...
This research finds empirical evidence that naked short sales contribute to the ability of investors to manipulatively short down the value of firms in need of external capital. The findings are also consistent with a hypothesis that the announcement effect of a new stock issue is merely a proxy for the value dilution of shorting shares of companies needing to raise new equity.
... First, Evans et al. (2008) use data from one market maker to link FTDs to hard-to-borrow situations and examine the possibility of arbitrage based on misalignments between the option and stock markets. Second, Boni (2006) analyzes delivery failures in U.S. equity markets. She finds that, prior to Regulation SHO, most U.S. equity issues, listed and unlisted, experienced at least a small percentage of failures-to-deliver each day. ...
... that the number of FTDs is strongly related to rebate rates, indicating that FTDs originate largely from (naked) short transactions; and Boni (2006) shows that the number of FTDs is related to the number of short sales, and offers evidence that market makers 'strategically' fail to deliver when borrowing costs are high, again pointing to FTDs being governed by (naked) short selling. Still, we undertake our own empirical analysis to more formally test for this conjecture, and, consistent with extant research, do not find any support for it. ...
Regulatory and media concern has focused heavily on the potentially manipulative distortion of market prices associated with naked short selling. However, naked shorting can also have beneficial effects for liquidity and pricing efficiency. We empirically investigate the impact of naked short-selling on market quality, and find that naked shorting leads to significant reduction in positive pricing errors, the volatility of stock price returns, bid-ask spreads, and pricing error volatility. We study naked shorting surrounding the demise of financial institutions hardest hit by the financial crisis in 2008 and find no evidence that stock price declines were caused by naked shorting. We also find that naked short-selling intensifies after rather than before credit downgrade announcements during the 2008 financial crisis. In general, we find that naked short sellers respond to public news and intensify their activity after price declines rather than triggering these price declines. We study the impact of the SEC ban on naked short selling of financial securities during July and August 2008, and find that the ban did not slow the price decline of those securities and had a negative impact on liquidity and pricing efficiency. Finally, after examining the speeds of mean reversion of pricing errors and order imbalances, we infer that Regulation SHO was successful in curbing the impact of manipulative naked short selling, and this reduction in the impact of manipulative naked shorting has continued through the 2008 financial crisis. Overall, our empirical results are in sharp contrast with the extremely negative pre-conceptions that appear to exist among media commentators and market regulators in relation to naked short-selling.
... We set this measure to zero for stocks not appearing in the SEC files for a given settlement date. Support for the notion that fails are governed by naked short selling is found in Boni (2006) and Evans et al. (2009), who find that market makers frequently strategically fail when it is expensive or impossible to borrow shares, and Fotak et al. (2009), who report that fails are significantly related to trading volume arising from short sales, but not significantly related to trading volume from regular (non-short) sales. ...
... • 12 See Boni (2006) for a detailed discussion of the institutional framework in which fails occur. ...
On July 15, 2008, the US Securities and Exchange Commission announced temporary restrictions on naked short sales of the stocks of 19 financial firms. The restrictions offer a unique empirical setting to test Miller's (1977) conjecture that short-sale constraints result in overpriced securities and low subsequent returns. Consistent with Miller's overpricing hypothesis, we find evidence of a positive (negative) market reaction to the announcement (expiration) of the short-sale restrictions. Announcement returns are higher for firms that appear to be subject to more naked short selling in the days immediately preceding the announcement of the restrictions. The restrictions are successful in eliminating naked short sales for the restricted stocks, but naked short sales increase dramatically for a closely matched sample of financial firms during the restricted period. We also find that the restrictions negatively impact various measures of liquidity, including bid-ask spreads and trading volume. From a public policy perspective, our findings suggest that, at a minimum, policymakers should pause when considering further short sale restrictions.
... If the seller's clearing member does not have the shares on account and has not borrowed shares on time for delivery, the clearing member will fail to deliver. There are many reasons that transactions might fail to deliver, but two recent studies conclude that some members might strategically fail to deliver (Boni (2005) and Evans, Geczy, Musto, and Reed (2006)). These studies suggest that participants might strategically fail when the cost to borrow securities is high and they promote the notion that failures to deliver might be a reasonable measure for " naked " short selling. ...
... The data contains the balance of fails to deliver as of a given day. 21 Our data is not as comprehensive as the data studied by Boni (2005) as it does not also include failures to receive, but our data does contain a much longer time series. ...
Short sale constraints in the aftermarket of initial public offerings (IPOs) are often used to explain short-term underpricing that is subsequently reversed. This paper shows that short selling is integral to aftermarket trading and is higher in IPOs with greater underpricing. Perceived restrictions on borrowing shares are not systematically circumvented by “naked” short selling. Short sellers, on average, do not appear to earn abnormal profits in the near term and our findings are not driven by market makers. Short selling in IPOs is not as constrained as suggested by the literature, implying that other factors may be responsible for underpricing.
... Failures to deliver (FTD) form in markets when one party in a trading contract fails to deliver on their obligation. 1 This failure should be randomly caused by human error or administrative delays, etc. Nevertheless, there is evidence and broad acceptance that using of FTDs to avoid fulfilment of obligations has been abused systematically (see for example Boni, 2006;Evans et al., 2008;Stratmann and Welborn, 2012;and Evans et al., 2021). One of the regulation actions conducted by the U.S. Securities and Exchange Commission (SEC) in 2009 2 led to a dramatic decline in common stock FTDs but a clear upward trend in ETF FTDs (Evans et al., 2021). ...
In this paper, we examine the potential of cycles in the valuation of GameStop Corp.
(GME) stocks, due to the unique exemptions in exchange traded fund (ETF)
creation/redemption activities. In order to satisfy liquidity in the market, a market maker
and/or authorised participant is allowed to sell ETF shares that have not yet been
created. With the use of wavelet coherence, we find evidence that ETF Failures to Deliver
(FTDs) formed consistent cycles in the day T+35 FTD clearing period. Results also
confirm less consistent but repeating cycles between the T+3 and T+6 periods. To the
best of our knowledge, we are the first in the literature to empirically examine the
potential of these cycles and their co-movement between FTD and stock prices.
... The accusation that major players abuse short selling and trade in nonexistent securities, by avoiding delivery requirements, has some support in the academic literature and, to a limited extent, by regulators. Boni (2006) argues that market makers and other major players strategically fail to deliver securities when it is advantageous for them to do so. Evans (2021) identifies risks to investors caused by naked short sales, even when performed for their intended purpose, and cites multiple incidents of improper use of short sales (1-7). ...
For the first six months of 2021 amateur analysts have enthusiastically poured over financial documents and the technical details of the US capital markets. The community hosting discussions about this movement, r/SuperStonk, receives millions of daily page views. The most visible and influential contributions to this online forum claim that there is widespread market manipulation, hopelessly inadequate regulation, and real opportunity for reform. Crucially, these claims have a broad audience, relate to a large volume and value of market activity, and appear to inform investing decisions. What began in January with dramatic media attention and volatile market activity in GameStop shares has developed into something quite distinct from its beginnings. Prominent members of this community now include experts from academia, investigative journalism, legal practice, and the finance industry. Highlights: 1. The retail investor movement that began in January 2021 has developed in sophistication and is growing in size. With daily page views in the millions, the influence of this movement relates to significant activity in the market. 2. Prominent members of this movement claim the US capital markets are fatally compromised by a large number of counterfeit shares that will result in a financial collapse more devastating than the 2007-8 global financial crisis. 3. Many appear to believe they can motivate reform, minimise the impact of an impending collapse, and profit by refusing to sell their GameStop shares until their continuing refusal reveals that a large number of the shares they hold are counterfeit.
... 14 Third, high stock borrow costs provide an incentive to naked short sell. This incentive is strong for market makers, who have historically chosen to fail-to-deliver on short sales when stock borrow prices were high (Boni et al., 2006;Evans et al., 2009;Stratmann and Welborn, 2012). Limited inventory of borrowable stock to sell short provides additional incentive to naked short sell. ...
... 14 Third, high stock borrow costs provide an incentive to naked short sell. This incentive is strong for market makers, who have historically chosen to fail-to-deliver on short sales when stock borrow prices were high (Boni et al., 2006;Evans et al., 2009;Stratmann and Welborn, 2012). Limited inventory of borrowable stock to sell short provides additional incentive to naked short sell. ...
Exchange-traded fund (ETF) trading volumes have increased over the last decade and so have ETF settlement failures at the clearing corporation. We test the hypothesis that ETF short selling, high stock borrow prices, and options contract expiration contribute to ETF fails-to-deliver (FTDs). We document a positive relationship between net daily ETF settlement failures and daily ETF short sale volume, the cost to borrow ETFs, and quarterly index options expiration dates (so-called “triple witching” dates). These findings are not consistent with the claim that fails are random. Rather, these findings are consistent with the hypothesis that market makers fail to deliver to avoid paying borrowing costs associated with their short sales. Further support for this hypothesis comes from a positive correlation between ETF FTDs and ETF put option open interest. Finally, we show that ETF settlement failures are important for the functioning of markets because they impact market index volatility. We find that positive changes in aggregate ETF FTDs Granger-cause higher market index volatility. We attribute this causality to buying and borrowing of common stock shares by market makers in order to close-out ETF FTD positions by trade date plus six days (“T 6”). We conclude that ETF FTDs are not inconsequential for market stability.
... According to Boni, (2006), the International Monetary Fund estimated that large U.S. and European banks lost more than $1 trillion on toxic assets and from bad loans from January 2007 to September 2009. These losses are expected to top $2.8 trillion from 2007-10. ...
The concept of globalization has come to most countries of the world primarily as that of necessity and rarely a matter of choice. For most countries, the sector that first gets entangled with the global web is the financial sector. No doubt because of the pivotal role performed by this sector. Nigeria on its part has not been left out. The nation’s financial sector strived to give it all it took in order to be counted and recognized among the leading financial institutions of the world. Their effort was compensated with the weight and dimension of juicy foreign capital that flowed into the banking industry during and after bank consolidation. They were soon to learn that globalization also carries with it, a baggage of complications which implies that an error of judgment or recklessness on the part of a partnering nation(s) can have a direct impact on the other nations that are part of the web the soundness of their banking practice notwithstanding. The attendant effect was the build up of nonperforming loans, low savings and deposit mobilization and a depressed economy. For the purpose of this study, two periods were identified; pre-consolidation (1999-2003) and the post consolidation period (2004-2008). We employed data extracted from CBN annual reports using the ordinary least square regression method to establish that the nonperforming loans that were a direct consequence of the financial crisis affected loans and advances and the savings and deposit mobilization of banks. We recommend that Nigeria should first develop an effective local policy before we can look forward to benefiting anything from our global affiliations.
... 23 " Short Sellers Squeezed All Around " , The Wall Street Journal (April 7, 2009). originate largely from (naked) short transactions; and Boni (2006) shows that the number of FTDs is related to the number of short sales, and offers evidence that market makers 'strategically' fail to deliver when borrowing costs are high, again pointing to FTDs being governed by (naked) short selling. Still, we undertake our own empirical analysis to more formally test for this conjecture, and, consistent with extant research, do not find any support for it. ...
Regulatory and media concern has focused heavily on the potentially manipulative distortion of market prices associated with naked short selling. However, naked shorting can also have beneficial effects for liquidity and pricing efficiency. We empirically investigate the impact of naked short-selling on market quality, and find that naked shorting leads to significant reduction in the volatility of stock price returns, a significant reduction in bid-ask spreads, a significant decline in pricing error volatility, and a significant decline in positive pricing errors. We study naked shorting surrounding the demise of financial institutions hardest hit by the financial crisis in 2008 and find no evidence that stock price declines were caused by naked shorting. We also find that naked short-selling intensifies after rather than before credit downgrade announcements during the 2008 financial crisis. In general, we find that naked short sellers respond to public news and intensify their activity after price declines rather than triggering these price declines. We study the impact of the SEC ban on naked short selling of financial securities during July and August 2008, and find that the ban did not slow the price decline of those securities and had a negative impact on liquidity and pricing efficiency. Finally, after examining the speeds of mean reversion of pricing errors and order imbalances, we infer that Regulation SHO was successful in curbing manipulative naked short selling. Overall, the negative regulatory and media concern is not supported by our empirical evidence.
... Next to the simultaneity concern, Boni (2006) and Evans, Geczy, Musto, and Reed (2009) show strategically fail-to-deliver shares when borrowing costs are high. I address strategic fails by examining the effect during the emerging order period in which strategic fails were no longer allowed. ...
Institutional investors can generate income by lending shares to short sellers. This paper shows that security prices incorporate expected future security lending income. To determine whether institutional investors anticipate lending profits, I examine how prices behave following a failure-to-deliver in the equity lending market. The difficulty to find shares gives lenders the ability to set high loan fees. The results show that high expected lending income in turn elevates prices, but that there is a trade-off between lending income and the implied negative information that arises from short selling. The results of this study imply that overpricing caused by the presence of short sale constraints is partly a result of rational capitalized lending income.
... shorting that is concentrated in foreign markets but also goes on in the U.S. because of inadequate enforcement by clearing agents (Boni, 2006) could be prevented by having the SEC start to enforce the laws requiring delivery of borrowed shares by short sellers. ...
This research evaluates the fundamental causes of the current financial crisis. Close financial analysis indicates that theoretical modeling based on unrealistic assumptions led to serious problems in mispricing in the massive unregulated market for credit default swaps that exploded upon catalytic rises in residential mortgage defaults. Recent academic research implies solutions to the crisis that are appraised to be far less costly than a bailout of investors who made poor financial decisions with respect to credit analysis.
... Second, this study advances our understanding of FTDs. Recent studies of FTDs include Boni (2006), who finds that the probability of FTDs is a function of a stock's short interest levels, and Evans et al. (2009), who find that failures outweigh deliveries when rebate rates are zero. Both studies suggest that FTDs are related to hard-to-borrow stocks. ...
We study persistent failures to deliver (fails) for insight into naked short sellers’ trading strategies, their ability to profit from their trades, and the market’s reaction to information about their activities. Contrary to recent claims that naked short sellers are momentum traders who drive down stock prices, we find that naked short sellers target stocks that experience positive returns and that returns are generally positive for several days following their trades. Thus, persistent fails suggest that naked short sellers are contrarian investors who find it difficult to earn consistent profits under the rules of Regulation SHO. The market tends to react positively when firms are added to the failures to deliver threshold lists, which we argue is indicative of increased naked short selling.
... Failures tend to occur when an investor who short sells a stock does not borrow shares in time for settlement. Boni (2006) and Evans, Geczy, Musto, and Reed (2009) argue that fails are more likely to occur in hard-to-borrow stocks. To the extent that fails reflect hard-to-borrow stocks, the overvaluation hypothesis predicts positive abnormal returns when excessive fails lead to a threshold listing and negative abnormal returns when a decline in the number of fails results in a threshold removal. ...
Studying a large sample of publicly available data on failures to deliver, we find that stocks reaching threshold levels of failures become significantly overvalued. Where short sale constraints are especially binding, we report extreme overpricing and subsequent reversals. These findings support the overvaluation hypothesis, although the mispricing is likely to be difficult to arbitrage because of extreme shorting costs. Moreover, threshold stocks with low short interest become more overvalued than threshold stocks with high short interest. This suggests that the level of short interest reflects supply-side effects when the examination conditions on the difficulty of borrowing shares.
... As an example, in the equity market, when sellers fail to deliver securities on time, the clearinghouse must assign the delivery failures across clearing members (seeBoni 2006). ...
We examine the behavior of call options surrounding the underlying stock's ex-dividend date. The evidence is inconsistent with the predictions of a rational exercise policy; a significant fraction of the open interest remains unexercised, resulting in a windfall gain to option writers. This triggers a sophisticated trading scheme that enables short-term traders to receive a significant fraction of the gains. The trading scheme inflates reported volume and distorts its traditional relations to liquidity. The dramatic increases in the volume of trade on the last cum-dividend day are facilitated by limitations on transaction costs passed by the various option exchanges. The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.
... 2. It should be mentioned that much of the recent shorting in practice has been alleged to be "naked", insofar as the stock for the short sales is not actually borrowed because the requirement to deliver shares is continuously postponed by clearing agents who effectively create the shares (Boni 2006). Such naked shorts, which are often channeled via a largely unregulated short trading environment such as in Canada (Brown 2002), may have no holding costs and have been alleged to exceed $1 trillion in amount (Financial Wire 2004). ...
This paper demonstrates analytically how short sellers can put non-transitory downward pressure on the stock market prices and intrinsic values of companies that need to raise external capital because of insufficient internal liquidity. The model helps explain anomalous empirical findings in the extant literature on negative returns to stocks subjected to heavy shorting activity. The implications of the model also supply normative justification for the sizable cash reserves held by corporations and their reluctance to raise external capital. The equity pricing effects implied by the model are illustrated for a large empirical sample of companies negatively impacted by heavy short sales. Empirical tests are also conducted in this research that provide evidence consistent with the theory.
... There are many different reasons why fails to deliver occur, including logistic reasons such as frictions associated with the delivery of paper stock certificates. Boni (2006) and Evans, Geczy, Musto, and Reed (2006) have also found that equity and option market makers sometimes strategically fail to deliver shares when loan fees are high. Market makers enjoy special exemptions from the RegSHO locate requirements (and these market participants were ultimately also exempted from the pre-borrow requirement of the emergency rule). ...
We create proxies for constrained supply of lendable shares by combining unique data on loan fees, stock lending activity, and failures to deliver to examine how often contrarian short sale strategies are affected by constraints. We find that constraints, as captured by our measures, clearly affect the strategies of NYSE and Nasdaq short sellers. In some cases 30%-40% of the cross-section experiences a significant reduction in the contrarian response of short sellers to past returns. However, only for extremely high levels of our constraint measures (top 1%) is contrarian behavior by short sellers completely eliminated. We also find that high minus low daily short selling activity portfolios produce abnormal returns for both constrained and unconstrained stocks.
... 41 For an analysis of the link between fails to deliver and option markets in the regulatory environment of the previous version of Regulation SHO see Evans et al. (2009). See Boni (2006) for a description of the earlier regulation. ...
This article examines the recent regulatory developments with regard to short selling. We begin with a comprehensive compilation of emergency restrictions on short selling adopted in the current crisis. Because of the tendency of some regulators to retain certain restrictions permanently, it is important to understand the fundamental legal and economic arguments regarding short selling. These arguments have at their core the question of whether there exists a market failure. The available evidence on balance suggests that short selling restrictions hamper the price discovery process. Also, while regulations against market abuse are required, it is an ineffective detour to pursue the goal of fair markets through the regulation of short selling. Based on these arguments, the article evaluates the approaches taken by the U.S. and U.K. regulators, who play a leading part in the current movement towards more comprehensive short selling regulation. The U.S. SEC’s recently adopted regulations do not seem to bring much added value and will presumably affect market efficiency in the negative. First principles suggest a somewhat more positive stance on the SEC’s proposal for a circuit breaker rule and the U.K. FSA’s proposed disclosure approach, though both are subject to caveats. We highlight some central questions for future research.
Given the complex and controversial nature of short-selling regulation, we review the academic literature and provide insights for policy makers and academics. We organize the complex history of short-selling regulation into three areas: trading restrictions, securities lending regulations, and disclosure requirements. We identify, analyze, and discuss 45 distinct regulations promulgated from 1896 to 2021, primarily by reviewing the academic literature and the data sources employed. We provide several insights regarding the effectiveness of regulatory approaches and the wider impact of short-selling regulation on markets. (JEL G2, G12, G14, G15, G34)
The short squeeze in GameStop attracted worldwide attention and resulted in congressional hearings. The increase in GameStop stock from an opening price of 483 on January 28 was not the result of obvious fundamental earnings prospects. Buying pressure from investors on a social media site accompanied by short covering, resulted in the stratospheric ascent of stock price. We use put–call parity to investigate the related issue of the no‐arbitrage violations before, during, and after the squeeze. We do not find evidence of abundant free money after accounting for short selling frictions.
Exploiting the setting of firms that are unable to disclose timely financial reports and thus must file with the U.S. Securities and Exchange Commission (SEC) the NT 10-K (Q) report, this study examines whether short sellers target firms with financial reporting weaknesses. We find that short interest increases in firms prior to the NT 10-K (Q) filing, suggesting that short sellers identify and target firms that cannot file their financial reports in a timely manner. Short selling is positively significantly related to subsequent late filing status, and is more pronounced in late filers with high newswire activity and with accelerated filing deadlines. Short selling of late filing firms is significantly negatively related to subsequent performance thereby suggesting that short sellers' trades pertinent to late filers are profitable. Overall, the results underscore a high information processing ability of short sellers in the setting of firms that exhibit financial reporting deficiencies.
zet Bu makalede, Türkiye Sermaye Piyasasında gerçekleşen açığa satış işlemleri ve uygulanan sınırlamalar ile aynı konuda A.B.D düzenlemeleri karşılaştırmalı incelenmiştir. Abstract This paper addresses the short selling regulations and restrictions in Turkey and compares the recent restrictions introduced by U.S. Securities and Exchange Commission regarding 2008 financial crisis.
During times of market turmoil, market regulators are often called upon to ban short selling. This paper considers a number of arguments commonly used to justify banning, which revolve around issues of volatility, stability, market abuse and settlement disruption. A literature review focusing on the 2008 period provides little evidence to support these arguments against short selling, suggesting that regulators should be circumspect when considering any future bans.
This chapter describes the relationship between short selling and settlement risk, the various determinants and consequences of settlement fails, and the settlement discipline framework provided by European securities settlement systems (SSSs) to contain disruptions resulting from settlement fails. Settlement risk is the risk that settlement of a financial transaction will not take place as expected usually due to a party defaulting on one or more settlement obligations. Settlement risk can be the result of the materialization of an operational risk, or due to legal enforcement, or a failed financial transaction. A financial transaction is said to "fail" if either the seller does not deliver the securities in due time or the buyer does not deliver funds in the appropriate form on the settlement. Parties failing to deliver due to a liquidity problem normally try to obtain credit or borrow the securities due for delivery. In some cases, the specific securities due for delivery may be difficult or very expensive to borrow as a result of thin markets or illiquid stocks. If the fail is not resolved promptly, settlement problems may propagate to other transactions and potentially trigger a disturbance of the smooth settlement process. Under extreme circumstances, the entire settlement process may be seriously affected or impaired unless corrective measures are taken to break the fails chain. Even securities lending markets for assets subject to a significant volume of fails could be affected negatively, as lenders may withhold collateral in the fear that the high fails in that security diminish the likelihood of the collateral being returned to them. Withholding scarce collateral may, in principle, contribute to increased fails rate and prolonging fails duration.
We study the determinants of fails-to-deliver in the period before and after the implementation of Rule 203 (elimination of option market maker exception from the locate and close-out requirement) and Rule 204 (t+3 close-out rule) in September 2008. We find a positive relation between short selling and fails-to-deliver that weakens after the implementation of these rules. Fails-to-deliver are higher for stocks with low institutional ownership, low book-to-market, small market capitalization, high turnover, and put option availability. The relation between short selling and these measures of borrowing costs is also weaker after the implementation of these rules.
Short selling plays a unique role in financial markets. Short selling's institutional structure is distinct from other types of trades, and short sellers have been shown to be more ormed than other types of traders. This review discusses short sellers' motivation, the institutional mechanics of short selling, the empirical findings on short selling, the regulation of short selling, the connection between corporate events and short selling, and the equity lending market. The review assesses the current direction of research as well as summarizes the current state of knowledge about the subject.
Purpose
– The purpose of this paper is to examine the relationship between naked short selling and accounting irregularities that cause a firm to issue a restatement.
Design/methodology/approach
– Using the level of abnormal fails-to-deliver as a proxy for naked short selling, the paper looks for evidence of increased naked short selling in anticipation of, as well as in response to these announcements.
Findings
– Larger firms and firms with a higher percentage of institutional ownership experience greater levels of fails prior to the announcement day, while smaller firms are more likely to be targets of naked short sellers after the announcement. The paper also finds that more transparent announcements are associated with more abnormal fails.
Originality/value
– This paper is the first research to study the relation between naked short selling and accounting restatements.
We thank Paul Bennett at the NYSE for providing system order data, and we are grateful to Greg Bauer and seminar participants at the Bank of Canada and the University of Arizona for helpful comments.
We investigate the aggregate market quality impact of equity shares that fail to deliver (hereafter “FTDs”). For a sample of 1,492 NYSE stocks over a 42-month period from 2005 to 2008, greater FTDs lead to higher liquidity and pricing efficiency, and their impact is similar to our estimate of delivered short sales. Furthermore, during the operative period of a Security and Exchange Commission (SEC) order mandating stock borrowing prior to short sales, the securities affected display relatively lower liquidity and higher pricing errors. Finally, we do not find any evidence that FTDs caused price distortions or the failure of financial firms during the 2008 financial crisis.
We use the 2008 short selling regulations to test whether short sale restrictions can increase informed short selling. For the preborrow requirement, we find more negative price reactions to short interest announcements though no reliable increase in the price impact of short sales volume. For the stocks with banned short sales, we find an increase in the price impact of short sale volume though no reliable change in the price reaction to short interest announcements. Both restrictions, however, are associated with increased informed trading. Our results suggest that short restrictions will not reduce informed short selling and may actually result in an increase by increasing the proportion of informed short sellers..
Purpose
On January 3, 2005, Regulation SHO was implemented by the Securities and Exchange Commission, with the express purpose of updating short sale regulation by seeking to limit an abusive short selling practice known as naked short selling. The purpose of this paper is to examine the efficacy and impact of Regulation SHO in achieving this goal of reducing naked shorting.
Design/methodology/approach
Time series analysis using fixed effects regression, Fama‐French‐Carhart model, various parametric and non‐parametric tests. The paper tests a number of hypotheses regarding the effectiveness of Regulation SHO in controlling naked shorts/fails‐to‐deliver in the American stock markets.
Findings
Utilizing several models, the authors find strong evidence in the first 30 to 60 days after being identified by Regulation SHO as having excessive naked short positions, those securities on average experienced further significant negative abnormal returns, indicating the regulation was at best ineffective. This result is robust for a number of parametric and non‐parametric tests. Models also show a security identified by Regulation SHO as having an excessive short position may actually suggest a profitable trading strategy of continuing to short those stocks. The regulation was largely ineffective/insignificant in reducing naked shorting. In addition, results revealed that a profitable investment could be made by shorting stocks as they were identified by Regulation SHO as already having excessive outstanding failure positions.
Originality/value
This is the first paper, to the authors' knowledge, that considers whether SHO was effective and offers intuition as to reasons why it was not.
Despite the expense, frustration, and slow implementation of electronic health records, hospital clinicians still believe in “imagined, ideal electronic records systems.”1 But is this a case of an emperor with no clothes? There is little hard evidence of benefits in patient outcome, and confidentiality concerns remain.2 The rigidity of analysable electronic records has been underestimated. Terminology and flow patterning of electronic questions are not standardised, yet every time data are duplicated, the human resources available for direct patient care are reduced.In 30 years’ experience of computerised maternity systems we have seen little progress. The most recent NHS-IT initiative, the national maternity services dataset,3 does not aim to improve patient care or reduce staff workload. It suggests that the purpose of electronically documenting over 400 data items for every pregnancy in the UK is for secondary management indications. This ignores the complexity of maternity software4; the minimal interconnectivity between different suppliers, and even within hospitals; and the cost and workload of implementing these decisions.Websites like the Electronic Encyclopaedia of Perinatal Data (www.eepd.info) provide an opportunity to examine and debate the value of each item of medical data (paper and electronic). Harnessing the expertise of clinicians worldwide using “electronic communities of practice” may help overcome the problems encountered with electronic records.5NotesCite this as: BMJ 2010;341:c5637FootnotesCompeting interests: RF is the originator of the Electronic Encyclopaedia of Perinatal Data (EEPD). He has served on virtually all UK national maternity notes and IT projects since 1980. From 1990 to 2001 he was reimbursed by Protos (now iSoft Evolution) for the use of his expert medical knowledge. He has had no commercial connection with them, or any other company, since 2001. HP is a volunteer coeditor of EEPD sections.References↵Robertson A, Cresswell K, Takian A, Petrakaki D, Crowe S, Cornford T, et al. Implementation and adoption of nationwide electronic health records in secondary care in England: qualitative analysis of interim results from a prospective national evaluation. BMJ 2010;341:c4564. (1 September.)OpenUrlFREE Full Text↵Delamothe T. How the internet’s unmanageability might play out. BMJ 2010;341:c5190.OpenUrlFREE Full Text↵Information Centre for Health and Social Care. Maternity services data set downloads. www.ic.nhs.uk/services/datasets/document-downloads/maternity.↵Fawdry R. Difficult areas of perinatal computing. Electronic Encyclopaedia of Perinatal Data, 2010. www.fawdry.info/eepd/01_ess/b_eprs/B08_Difficult.pdf. ↵Ho K, Jarvis-Selinger S, Norman CD, Li LC, Olatunbosun T, Cressman C, et al. Electronic communities of practice: guidelines from a project. J Contin Educ Health Prof2010;30:139-43.OpenUrlCrossRefMedline
Regulations allow market makers to short sell without borrowing stock, and the transactions of a major options market maker
show that in most hard-to-borrow situations, it chooses not to borrow and instead fails to deliver stock to its buyers. A
part of the value of failing passes through to options prices: when failing is cheaper than borrowing, the relation between
borrowing costs and options prices is significantly weaker. The remaining value is profit to the market maker, and its ability
to profit despite competition between market makers appears to result from the cost advantage of larger market makers.
We investigate whether the existence of traded options represents an economically important relaxation of short sale constraints. Our analysis has three prongs. First, to the extent that option listing relaxes a binding constraint, we would expect to see investors taking synthetic short positions in the newly-listed options. Contrary to this hypothesis, we find that the volume of newly-listed options tends to be very low, and, if anything, signed volume is more bullish that bearish during the first week of trading. Moreover, we find no significant relation between signed option volume and abnormal stock returns surrounding option listing. Second, if options help relax binding short-sale constraints, we might expect bearish option volume to be positively related to proxies for short sale constraints, divergence of opinion, and/or overvaluation. We examine nine different proxies and combinations of proxies, and in each case find either no relation, or a significant negative relation. Third, we demonstrate that prior results in the literature reporting a negative price reaction surrounding option listing are not robust to alternative methodological assumptions. All our evidence suggests that options do not reduce short sale constraints in an economically meaningful way.
In September 2008, the U.S. Securities and Exchange Commission (SEC) temporarily banned most short sales in nearly 1,000 financial
stocks. We examine the ban's effect on market quality, shorting activity, the aggressiveness of short sellers, and stock prices.
The ban's effects are concentrated in larger stocks; there is little effect on firms in the lower half of the size distribution.
Although shorting activity drops by about 77% in large-cap stocks, stock prices appear unaffected by the ban. All but the
smallest quartile of firms subject to the ban suffer a severe degradation in market quality.
We examine daily short selling of Nasdaq stocks to explore whether speculative short selling causes a significant portion of the weekend effect in returns. We identify a weekend effect in speculative short selling whereby it constitutes a larger percentage of trading volume on Mondays versus Fridays. We find an opposite effect in dealer short selling, consistent with market makers adding liquidity and stability. Our main finding is that speculative short selling does not explain an economically meaningful portion of the weekend effect in returns, even among the firms most that are most actively shorted. This finding contradicts some prior studies. Copyright (c) 2009, The Eastern Finance Association.
The standard analysis of corporate governance is that shareholders vote in the ratios that firms choose, such as one-share-one-vote. But if the cost of unbundling and trading votes is sufficiently low, then shareholders vote in the ratios that they themselves choose. We document an active market for votes within the equity-loan market, where we find that the average vote sells for zero. We hypothesize that asymmetric information motivates these vote reallocations, and we find support for this view in the cross section of votes: there is more trade for higher-spread firms and more for poor performers, especially when the vote is close. We also find that the vote reallocations correspond to support for shareholder proposals and opposition to management proposals.
L'analyse classique de la gouvernance d'entreprise suppose que les actionnaires votent selon les modalités choisies par la firme, par exemple un vote par action. Mais si les coûts associés à la séparation et à l'échange des votes sont suffisamment faibles, alors les actionnaires votent selon les modalités qu'ils ont eux-mêmes choisies. Nous présentons le cas d'un marché actif de votes au sein du marché des mises de fonds sous forme d'emprunts (equity loans), où nous constatons qu'en moyenne les votes se vendent pour rien. Nous supposons que l'asymétrie d'information provoque cette réallocation des votes, et nous étayons cette hypothèse à travers l'étude transversale des votes : le nombre d'opérations est plus important pour les compagnies dont l'écart acheteur-vendeur est plus élevé ainsi que pour celles dont les résultats sont plus faibles, particulièrement lorsque le vote est clos. Cette étude montre aussi que la réallocation des votes permet de soutenir les propositions des actionnaires et de s'opposer à celles des gestionnaires.
We argue that short sellers affect prices in a significant and systematic manner. In particular, we contend that speculative short sales contribute to the weekend effect: The inability to trade over the weekend is likely to cause these short sellers to close their speculative positions on Fridays and reestablish new short positions on Mondays causing stock prices to rise on Fridays and fall on Mondays. We find evidence in support of this hypothesis based on a comparison of high short-interest stocks and low short-interest stocks, stocks with and without actively traded options, IPOs, zero short-interest stocks, and highly volatile stocks. Copyright 2003 by the American Finance Association.
We develop a model of stock prices in which there are both differences of opinion among investors as well as short-sales constraints. The key insight that emerges is that breadth of ownership is a valuation indicator. When breadth is low - i.e., when few investors have long positions in the stock - this signals that the short-sales constraint is binding tightly, implying that prices are high relative to fundamentals and that expected returns are therefore low. Thus reductions (increases) in breadth should forecast lower (higher) returns. Using quarterly data on mutual fund holdings over the period 1979-1998, we find evidence supportive of this predictions: stocks whose change in breadth in the prior quarter places them in the lowest decile of the sample underperform those in the top change-in-breadth decile by 6.38% in the first twelve months after portfolio formation. After adjusting for size, book-to-market and momentum, the corresponding figure is 4.95%.
Recent equity carve-outs in U. S. technology stocks appear to violate a basic premise of financial theory: identical assets have identical prices. In our 1998-2000 sample, holders of a share of company A are expected to receive x shares of company B, but the price of A is less than x times the price of B. A prominent example involves 3Com and Palm. Arbitrage does not eliminate this blatant mispricing due to short-sale constraints, so that B is overpriced but expensive or impossible to sell short. Evidence from options prices shows that shorting costs are extremely high, eliminating exploitable arbitrage opportunities.
Regulations allow market makers to short sell without borrowing stock, and the transactions of a major options market maker show that in most hard-to-borrow situations, it chooses not to borrow and instead fails to deliver stock to its buyers. Some of the value of failing passes through to option prices: when failing is cheaper than borrowing, the relation between borrowing costs and option prices is significantly weaker. The remaining value is profit to the market maker, and its ability to profit despite the usual competition between market makers appears to result from a cost advantage of larger market makers at failing.
We introduce a new approach to ranking U.S. equity underwriters, the ELO system. This system was originally developed for ranking chess players, and has subsequently been used to rank competitors in many other areas. In our implementation, we view an equity offering as a contest in which participating members of the underwriting syndicate compete for prestige as measured by their relative proportion of shares underwritten. Banks that underwrite a greater portion of the shares in a particular offering are viewed as “defeating” those with smaller allocations. Based on 7,713 IPOs and 6,345 SEOs from 1978 to 2009, we use this approach to rank banks actively participating in equity underwriting syndicates across five subperiods. First Boston is the highest ranked investment bank in the first of these periods (1978-84) and Goldman Sachs is the highest ranked in the most recent period (2005-09). The ELO system overcomes several of the disadvantages of existing ranking systems and in empirical tests does better than the Carter-Manaster ranking system in measuring prestige. Similar to other studies, we find that the prestige of the lead underwriter, as measured by its ELO rating, is negatively related to IPO underpricing in the 1980s and positively related to IPO underpricing in the 1990s and 2000s. Prestige is negatively related to SEO underpricing across all three decades.
We employ a novel equity loan database to study the effect of short-sale constraints on the informational efficiency of stock prices. Specifically, we use a direct measure of short-selling costs to test the Diamond and Verrecchia (1987) hypothesis that short-sale constraints reduce the speed at which prices adjust to private information. We show that stocks for which short-selling is particularly costly have larger price reactions to earnings announcements, especially to bad news. We confirm the prediction that the distribution of announcement-day returns will be more left-skewed and returns will be larger in absolute value. Furthermore, the fraction of long-run price reaction realized on the day of the announcement is smaller when short-selling is constrained.
This study examines battles between short sellers and firms. Firms use a variety of methods to impede short selling, including
legal threats, investigations, lawsuits, and various technical actions intended to create a short squeeze. These actions create
short sale constraints. Consistent with the hypothesis that short sale constraints allow stocks to be overpriced, firms taking
anti-shorting actions have in the subsequent year very low abnormal returns of about −2% per month.
A share's ownership of record can trade separately from its beneficial ownership, through equity loans. In a year of transactions by a major lender, we analyze the market for ownership of record on dates when this ownership is important: the record dates of votes, when loans transfer votes, and of distributions, when loans determine the direct recipient of the distributions. On voting record dates, the lender's loan volume is high relative to surrounding days, particularly so for proposals related to lagging firms and of those, especially the proposals with close votes. Loan volume associates with greater support for shareholder proposals, and weaker support for management proposals. We also find substantial lending on dividend record dates of firms with reinvestment discounts and loan pricing that is low but increasing with the implied profit. On the record dates of Canadian firms' dividends we find that U.S. investors subject to withholding can reclaim 95% of the marginal unit of dividend yield using equity loans. We also find that, consistent with the Canadian dividend tax credit, the stock market capitalizes this marginal unit at more than its full cash value. For the cross section of Canadian firms these findings predict, and portfolio data confirm, that dividends reduce investment by U.S., relative to Canadian, institutions.
We present a model of asset valuation in which short-selling requires searching for security lenders and bargaining over the lending fee. If lendable securities are difficult to locate, then the price of the security is initially elevated, and expected to decline. This price decline is to be anticipated, for example, after an initial public offering, and is increasing in the degree of heterogeneity of beliefs about the future value of the security. The prospect of lending fees may push the initial price of a security above even the most optimistic buyer's valuation of the security's future dividends. A higher price can thus be obtained with some shorting than if shorting is disallowed.
Stocks can be overpriced when short-sale constraints bind. We study the costs of short-selling equities from 1926 to 1933, using the publicly observable market for borrowing stock. Some stocks are sometimes expensive to short, and it appears that stocks enter the borrowing market when shorting demand is high. We find that stocks that are expensive to short or which enter the borrowing market have high valuations and low subsequent returns, consistent with the overpricing hypothesis. Size-adjusted returns are 1–2% lower per month for new entrants, and despite high costs it is profitable to short them.
To short a stock, an arbitrageur must first borrow it. This paper describes the market for borrowing and lending U.S. equities, emphasizing the conditions generating and sustaining short-sale constraints. A large institutional lending intermediary provided eighteen months (4/2000–9/2001) of data on loan supply (“shortability”), loan fees (“specialness”), and loan recalls. The data suggest that while loan market specials and recalls are rare on average, the incidence of these short-sale constraints is increasing in the divergence of opinion among investors. Beyond some threshold, investor optimism itself can limit arbitrage via the loan market mechanism.
Settlement fails, which occur when securities are not delivered and paid for on the date scheduled by the buyer and seller, can expose market participants to the risk of loss due to counterparty insolvency. This article examines the institutional and economic setting of the fails problem that affected the Treasury market following September 11 and describes how the Federal Reserve and the U.S. Treasury responded. The authors explain that fails rose initially because of the physical destruction of trade records and communication facilities. Fails remained high because a relatively low federal funds rate and investor reluctance to lend securities kept the cost of borrowing securities to avert or remedy a fail comparable to the cost of continuing to fail. The fails problem was ultimately resolved when the Treasury increased the outstanding supply of the on-the-run ten-year note through an unprecedented "snap" reopening. The article also suggests other ways to alleviate chronic fails, such as the introduction of a securities lending facility run by the Treasury and the institution of a penalty fee for fails.
With a year of equity loans by a major lender, we measure the effect of actual short-selling costs and constraints on trading strategies that involve short-selling. We find the loans of initial public offering (IPOs), DotCom, large-cap, growth and low-momentum stocks to be cheap relative to the strategies’ documented profits and that investors who can short only stocks that are cheap and easy to borrow can enjoy at least some of the profits of unconstrained investors. Most IPOs are loaned on their first settlement days and throughout their first months, and the underperformance around lockup expiration is significant even for the IPOs that are cheap and easy to borrow. The effect of short-selling frictions appears strongest in merger arbitrage. Acquirers’ stock is expensive to borrow, especially when the acquirer is small, though the major influence on trading profits is not through expense but availability.
We test whether short-sellers in U.S. stocks are able to predict future returns based on new SEC-mandated data for 2005. There is a tremendous amount of short-selling activity during the sample: short-sales represent 24 percent of NYSE and 31 percent of Nasdaq share volume. Short-sellers increase their trading following positive returns and they correctly predict future negative abnormal returns. These patterns are robust to controlling for voluntary liquidity provision and for opportunistic risk-bearing by short-sellers. The results are consistent with the hypothesis that short-sellers are trading on short-term overreaction in stock returns. A trading strategy based on daily short-selling activity generates significant positive returns during the sample period.
This paper examines short-sales transactions in the five days prior to earnings announcements of 913 Nasdaq-listed firms. The tests provide evidence of informed trading in pre-announcement short-selling because they reveal that abnormal short-selling is significantly linked to post-announcement stock returns. Also, the tests indicate that short-sellers typically are more active in stocks with low book-to-market valuations or low SUEs. The levels of pre-announcement short-selling, however, mostly appear to reflect firm-specific information rather than these fundamental financial characteristics. We believe that these results should encourage financial market regulators to consider providing more extensive and timely disclosures of short-selling to investors. Copyright 2004 by The American Finance Association.
This paper examines the relationship between the level of short interest and stock returns in the Nasdaq market from June 1988 through December 1994. We find that heavily shorted firms experience significant negative abnormal returns ranging from - 0.76 to - 1.13 percent per month after controlling for the market, size, book-to-market, and momentum factors. These negative returns increase with the level of short interest, indicating that a higher level of short interest is a stronger bearish signal. We find that heavily shorted firms are more likely to be delisted compared to their size, book-to-market, and momentum matched control firms. Copyright The American Finance Association 2002.
We develop a model of stock prices in which there are both differences of opinion among investors as well as short-sales constraints. The key insight that emerges from the model is that breadth of ownership is a valuation indicator. When breadth is low---i.e., when few investors have long positions in the stock---this signals that the short-sales constraint is binding tightly, implying that prices are high relative to fundamentals and that expected returns are therefore low. Thus reductions (increases) in breadth should forecast lower (higher) returns. Another prediction is that changes in breadth should be positively correlated with other variables that forecast increased risk-adjusted returns. Using quarterly data on mutual fund holdings over the period 1979-1998, we find evidence supportive of both of these predictions.
How and why do investors trade votes, and what does it mean? Working paper Short-selling prior to earnings announcements
- S E K Christoffersen
- C C Geczy
- D K Musto
- A V Reed
- S E Christophe
- M G Ferri
- J J Angel
Christoffersen, S.E.K., Geczy, C.C., Musto, D.K., Reed, A.V., 2004. How and why do investors trade votes, and what does it mean? Working paper, Wharton. Christophe, S.E., Ferri, M.G., Angel, J.J., 2004. Short-selling prior to earnings announcements. Journal of Finance 59, 1845–1875.
1–26 Betas are calculated using daily returns for the prior year. The market return is based on all U.S. listed stocks. Dollar-weighted betas are calculated using the dollar amounts of fails in each stock as weights
- L Boni
L. Boni / Journal of Financial Markets 9 (2006) 1–26 Betas are calculated using daily returns for the prior year. The market return is based on all U.S. listed stocks. Dollar-weighted betas are calculated using the dollar amounts of fails in each stock as weights. L. Boni / Journal of Financial Markets 9 (2006) 1–26 References
Who is #1? A New Approach to Ranking
- Hill Cooney
- Jordan
- U Singh
Cooney, Hill, Jordan, and Singh, 2004, " Who is #1? A New Approach to Ranking U,S, IPO
Underwriters, " working paper, Texas Tech.
When the back office moved to the front burner: settlement fails in the treasury market after 9/11. Federal Reserve Bank of New York Economic Policy Review
- M J Fleming
- K D Garbade
Go down fighting: short sellers vs. firms. Working paper
- O A Lamont