Forward Premiums in the Brussels SE and the Shadow Price of Cash Balances

Investors who want to profitably trade stocks which they believe to be undervalued or overvalued are facing not just transaction costs: also cash constraints and short-selling restriction can hinder them. Intuitively, the more onerous friction may seem to be short-selling: borrowing shares from someone else and selling them looks more of a hassle than borrowing money or using an overdraft facility. By examining the observed forward premiums in the Brussels Stock Exchange during the period 1989-1996, this study aims at uncovering which of the two types of restrictions had the biggest impact on trading: how often was shortselling the dominant problem, what was the implied shadow cost of the imperfection, and how persistent were the symptoms? We first test whether forward premiums are fully explained by the settlement effect, we find that the time value signal is significant in forward premiums, but the effect is below our theoretical priors. Next, we show theoretically that a positive forward premium is more likely in a situation in which the order volume from cash-constrained buyers exceeds that of sellers without a long position. Likewise, a negative forward premium typically means that the order volume from sellers without long positions exceeds that of cash-constrained buyers. We find that abnormally high forward premiums are 2.5-3 times more frequent and larger than negative premiums, and that they persist in time, unlike negative premiums. Thus, contrary to what many academics may have expected, getting money loans seems to be a more frequent, more expensive, and more persistent problem than asset borrowing.