In Short Supply: Short-Sellers and Stock Returns

We examine the economic determinants of short-sale supply, and its consequences for future stock returns.  Lendable supply increases with expected borrowing costs and decreases with financial statement constructs that indicate overvaluation.  Although rising loan fees help ease supply constraints, we find shares are still least available when they are most attractive to short sellers.  Using a number of firm characteristics, we derive useful instruments for real-time loan supply and demand conditions in the lending market.  Further, we show that (1) when lendable supply is binding (non-binding), short-sale supply (demand) is the main predictor of future stock returns, (2) abnormal returns to the short-side of nine well-known market anomalies are attributable solely to “special” stocks, and (3) loan fees significantly reduce the profitability of the short side and several of these anomalies cease to be profitable.  Overall our evidence highlights the central role played by the supply of lendable shares in equity price formation and returns prediction.