IDEAS home Printed from https://ideas.repec.org/p/arx/papers/1903.11804.html
   My bibliography  Save this paper

Short Selling with Margin Risk and Recall Risk

Author

Listed:
  • Kristoffer Glover
  • Hardy Hulley

Abstract

Short sales are regarded as negative purchases in textbook asset pricing theory. In reality, however, the symmetry between purchases and short sales is broken by a variety of costs and risks peculiar to the latter. We formulate an optimal stopping model in which the decision to cover a short position is affected by two short sale-specific frictions---margin risk and recall risk. Margin risk refers to the fact that short sales are collateralised transactions, which means that short sellers may be forced to close out their positions involuntarily if they cannot fund margin calls. Recall risk refers to a peculiarity of the stock lending market, which permits lenders to recall borrowed stock at any time, once again triggering involuntary close-outs. We examine the effect of these frictions on the optimal close-out strategy and quantify the loss of value resulting from each. Our results show that realistic short selling constraints have a dramatic impact on the optimal behaviour of a short seller, and are responsible for a substantial loss of value relative to the first-best situation without them. This has implications for many familiar no-arbitrage identities, which are predicated on the assumption of unfettered short selling.

Suggested Citation

  • Kristoffer Glover & Hardy Hulley, 2019. "Short Selling with Margin Risk and Recall Risk," Papers 1903.11804, arXiv.org.
  • Handle: RePEc:arx:papers:1903.11804
    as

    Download full text from publisher

    File URL: http://arxiv.org/pdf/1903.11804
    File Function: Latest version
    Download Restriction: no

    References listed on IDEAS

    as
    1. Owen A. Lamont & Richard H. Thaler, 2003. "Can the Market Add and Subtract? Mispricing in Tech Stock Carve-outs," Journal of Political Economy, University of Chicago Press, vol. 111(2), pages 227-268, April.
    2. Cai, Ning & Sun, Lihua, 2014. "Valuation of stock loans with jump risk," Journal of Economic Dynamics and Control, Elsevier, vol. 40(C), pages 213-241.
    3. Zuo Quan Xu & Fahuai Yi, 2019. "Optimal redeeming strategy of stock loans under drift uncertainty," Papers 1901.06680, arXiv.org.
    4. Jun Liu, 2004. "Losing Money on Arbitrage: Optimal Dynamic Portfolio Choice in Markets with Arbitrage Opportunities," Review of Financial Studies, Society for Financial Studies, vol. 17(3), pages 611-641.
    5. Ofek, Eli & Richardson, Matthew & Whitelaw, Robert F., 2004. "Limited arbitrage and short sales restrictions: evidence from the options markets," Journal of Financial Economics, Elsevier, vol. 74(2), pages 305-342, November.
    6. Shleifer, Andrei & Vishny, Robert W, 1997. "The Limits of Arbitrage," Journal of Finance, American Finance Association, vol. 52(1), pages 35-55, March.
    7. Erik Ekström & Bing Lu, 2011. "Optimal Selling of an Asset under Incomplete Information," International Journal of Stochastic Analysis, Hindawi, vol. 2011, pages 1-17, December.
    8. Joseph K. W. Fung & Paul Draper, 1999. "Mispricing of index futures contracts and short sales constraints," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 19(6), pages 695-715, September.
    9. Matheus R. Grasselli & Cesar Gómez, 2013. "Stock Loans in Incomplete Markets," Applied Mathematical Finance, Taylor & Francis Journals, vol. 20(2), pages 118-136, April.
    10. Shuqing Jiang & Zongxia Liang & Weiming Wu, 2010. "Stock loan with Automatic termination clause, cap and margin," Papers 1005.1357, arXiv.org, revised Sep 2010.
    Full references (including those not matched with items on IDEAS)

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:arx:papers:1903.11804. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (arXiv administrators). General contact details of provider: http://arxiv.org/ .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.