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Asset pricing with costly short sales

Author

Listed:
  • Theodoros Evgeniou

    (INSEAD)

  • Julien Hugonnier

    (Swiss Federal Institute of Technology Lausanne - Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute)

  • Rodolfo Prieto

    (INSEAD)

Abstract

We study a dynamic general equilibrium model with costly-to-short stocks and heterogeneous 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 pricing formula implies that returns satisfy a modified capital asset pricing model with an adjustment for the lending yield and sheds light on recent findings about the explanatory power of lending fees in the cross-section of returns. In particular, we show empirically that once returns are appropriately adjusted for lending fees, stocks with low and high shorting costs offer similar risk-return tradeoffs.

Suggested Citation

  • Theodoros Evgeniou & Julien Hugonnier & Rodolfo Prieto, 2022. "Asset pricing with costly short sales," Swiss Finance Institute Research Paper Series 22-21, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp2221
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    Keywords

    Shorting fees; Securities lending; Heterogeneous beliefs; Dynamic equilibrium.;
    All these keywords.

    JEL classification:

    • D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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