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THE JOURNAL OF FINANCE

VOL. LXVIII, NO. 2

APRIL 2013
A Multiple Lender Approach to Understanding
Supply and Search in the Equity Lending Market
ADAM C. KOLASINSKI, ADAM V. REED, and MATTHEW C. RINGGENBERG

ABSTRACT
Using unique data from 12 lenders, we examine how equity lending fees respond to
demand shocks. We nd that, when demand is moderate, fees are largely insensitive
to demand shocks. However, at high demand levels, further increases in demand lead
to signicantly higher fees and the extent to which demand shocks impact fees is also
related to search frictions in the loan market. Moreover, consistent with search mod-
els, we nd signicant dispersion in loan fees, with this dispersion increasing in loan
scarcity and search frictions. Our ndings imply that search frictions signicantly
impact short selling costs.
SHORT SALE CONSTRAINTS MOTIVATE a large body of theoretical research in asset
pricing. In addition, a growing body of empirical work conrms that these
constraints have an economically meaningful impact.
1
Although this research
suggests that short sale constraints are important, relatively few empirical
studies attempt to explain the variation of short sale constraints across stocks,
and even fewer seek to provide a motivation for the origin of these constraints.
Short sale constraints can take many forms, but one of the most important
is the fee that short sellers pay to borrow shares in the equity lending market.
Despite its one trillion dollar size, relatively little is known about this mar-
ket because transactions are usually only visible to the two parties directly
involved.
2
Furthermore, the equity loan databases employed in the existing

University of Washington, University of North Carolina, and Washington University in


St. Louis, respectively. The authors thank Robert Battalio, Darrell Dufe, Nicolae G arleanu,
Jennifer Huang, David Musto, Lasse Pedersen, an anonymous referee, the Editors, and semi-
nar participants at the American Finance Association Conference, Barclays Global Investors, the
Consortium for Financial Economics and Accounting Conference, the European Finance Associa-
tion Conference, the IIROC-DeGroote Conference on Market Structure, Texas A&M, the University
of Oregons Institutional Asset Management Conference, the University of Virginia, and the Uni-
versity of Washington. We are grateful for nancial support from the Q Group. Our data provider
made this work possible and provided invaluable advice over the course of numerous discussions.
Finally, we thank William Frohnhoefer for providing institutional details.
1
The theoretical literature on short selling includes Miller (1977), Diamond and Verrecchia
(1987), and Hong and Stein (1999), and empirical work demonstrating the signicant economic
impact of short sale constraints includes Geczy, Musto, and Reed (2002), Ofek and Richardson
(2003), Asquith, Pathak, and Ritter (2005), and Cao et al. (2008).
2
Conversations with industry participants indicate that this is slowly changing. A central
counterparty exchange is slowly gaining volume (the exchange currently handles less than 1% of
volume).
559
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literature are provided by individual equity lenders, so researchers have not
had an opportunity to draw conclusions about market-wide characteristics. As
a result, a number of important questions remain unanswered: How much
short selling can take place before borrowing shares becomes expensive? What
causes borrowing to become expensive? What are the characteristics of the
share lending supply curve? And, nally, how much variation in fees could a
borrower expect to see across multiple lenders? We nd that the answers to
these questions are related to the presence of search frictions in the equity
lending market.
The general dearth of empirical research on the equity lending market is
inherently linked to its opacity, and one of the primary goals of this paper is
to analyze the effects of this opacity. In one of the few theoretical models of
the equity loan market, Dufe, G arleanu, and Pedersen (2002, hereafter DGP)
suggest that search frictions, which result from opacity, give share lenders
market power, allowing them to charge fees to short sellers. We examine this
model empirically in a number of ways. First, we nd signicant dispersion
in loan fees, which is consistent with the existence of search frictions in the
share loan market. In addition, using stock characteristics that DGP suggest
as proxies for search frictions, we show that search frictions are related to
loan fee dispersion. Finally, we nd that loan fee dispersion sharply increases
as the average loan fee moves from moderate to high levels, consistent with
DGPs hypothesis that search frictions are related to the costs of short selling.
However, the relation between the average fee and the dispersion in fees is
not monotonic: dispersion is also high when the average fee is abnormally low,
resulting in a U-shaped pattern.
We also examine how search frictions allow lenders to change their prices in
response to exogenous shifts in demand. In the existing literature, some con-
troversy exists regarding the way demand affects prices; some researchers nd
that lending fees are unresponsive to increases in quantity (e.g., Christoffersen
et al. (2007)), whereas others nd that large positive shifts in the demand for
share loans can be manifested in increased lending fees (e.g., Cohen, Diether,
and Malloy (2007)). We resolve this apparent paradox by using a nonlinear
two-stage least squares method to estimate the share loan supply schedule.
We nd that the loan supply schedule is essentially at, and that specialness
is invariant to quantity demand shocks most of the time. For example, for the
average stock a movement fromthe 10th quantity percentile to the 90th results
in a loan fee change of only ve basis points. However, the slope of the supply
schedule becomes positive and steep when demand shocks drive quantity to ab-
normally high levels, consistent with Cohen, Diether, and Malloy (2007).
3
For
example, a one standard deviation increase from the third to fourth standard
3
Cohen, Diether, and Malloys (2007) results connect the demand for share loans to underlying
stock prices, and their study identies changes in demand based on measured changes in prices
and quantities in the stock loan market. One of the goals of this study is to understand exactly
how changes in demand for share loans affect prices for those loans. In effect, were estimating the
underlying relation that gives rise to loan price changes and asking how that relation is affected
by the presence of search costs and market structure.
Supply and Search in the Equity Lending Market 561
deviation of quantity is associated with a movement in abnormal loan fees from
3.2 basis points to 21.7 basis points.
To further investigate the relation between the supply curve and search fric-
tions, we examine how the shape of the supply curve relates to several proxies
for search frictions. We nd evidence that the share loan supply schedule is
steeper at high quantity levels when search costs are higher. In addition, we
examine whether factors unrelated to search costs can explain the patterns in
the data that we attribute to search costs. First, we nd that variation in the
types of lenders active in a particular stocks loan market can explain some
of the cross-lender dispersion in specialness. It is therefore likely that differ-
ences in lender desirability are at least partly responsible for the dispersion we
observe. However, our proxies for search costs continue to have a signicant
effect on dispersion even after controlling for variation in lender type. Second,
we examine whether concentration in lender capacity, which could result in in-
creased market power when quantity demanded is high, can explain our nding
that supply curves tend to become steep at high quantity levels. However, con-
trary to this hypothesis, we nd that the loan supply curve is not statistically
different between low and high levels of lender capacity concentration.
Our research has important policy implications. Because search frictions
have a signicant impact on lending fees, it follows that a reduction in these
frictions would loosen short sale constraints. One way to reduce search fric-
tions is to introduce a central clearinghouse for share loans, such as the NYSE
lending post that was abandoned in the 1930s. Furthermore, there is evidence
that short sale constraints reduce market efciency (e.g., Asquith, Pathak,
and Ritter (2005), Nagel (2005), Reed (2007), and Cao et al. (2008)). Although
some regulators and journalists accused short sellers of disrupting markets
and reducing efciency during the nancial crisis of 2008, a large body of re-
cent research suggests that market quality decreased after short sales were
restricted in response to the crisis (e.g., Bris (2009), Boehmer, Jones, and
Zhang (2009), Boulton and Braga-Alves (2010), Kolasinski, Reed, and Thornock
(2013)). Taken together, these results suggest that centralizing the share loan
market could potentially improve stock market efciency. However, as Jones
and Lamont (2002) document, some stocks became expensive to borrow even
with a lending post. Further, we nd other factors, in addition to search fric-
tions, that can make borrowing expensive. Thus, although it is unlikely that a
central clearinghouse would eliminate all borrowing difculty in the share loan
market, our evidence suggests that search frictions are a signicant contributor
to borrowing costs.
Finally, our ndings also have broader implications for opaque nancial mar-
kets. The theoretical models we use to motivate our empirical tests need not
be limited to the equity lending market. Insofar as their underlying assump-
tions of agent heterogeneity, search frictions, and the lack of centralized price
quoting are consistent with the institutional details of other over-the-counter
markets, our results can be generalized to those contexts.
The remainder of this paper proceeds as follows. Section I examines the
search cost literature and explores the applicability of search cost models to
562 The Journal of Finance
R
the equity lending market with a particular focus on the ability of search
frictions to generate short sale constraints, and the resulting empirical impli-
cations. Section II describes the databases used in this study and Section III
characterizes our ndings. Section IV presents our summary and conclusion.
I. Search Frictions and the Share Lending Market
A. Specialness, Search Frictions, and Price Dispersion
DGPpresent a dynamic model in which search frictions limit the frequency at
which share lenders and borrowers are able to nd one another. Thus, lenders,
if they have some bargaining power, are able to charge a lending fee to short
sellers that is equal to some fraction of the surplus short sellers believe they
can gain. Short sellers are willing to pay the fee because, if they refuse, they
might not be able to nd another lender and thus would have to forgo their
surplus. Over time, this lending fee declines to zero as short sellers drive down
prices to their long-run equilibrium values. The magnitude of the lending fee,
often termed specialness, is increasing in lenders bargaining power, in frictions
in the share lending market, and in demand for share loans.
In our investigation, we also draw on the industrial organization literature
on search costs and price dispersion. When there is heterogeneity in seller
costs, models in which buyers must search sequentially for a seller generally
yield a positive relation between average prices, price dispersion across sellers,
and search costs (Reinganum (1979), Sirri and Tufano (1998), Baye, Morgan,
and Scholten (2006)). The DGP model does not predict dispersion in fees across
lenders because it assumes no heterogeneity in lenders costs of providing share
loans (DGP assume lenders costs are zero). However, in practice it is likely
that some heterogeneity in lenders costs does exist, so if search frictions drive
specialness, we would expect an increased average level of specialness to be
associated with increased dispersion in specialness across lenders. Using data
from multiple lenders, we compute dispersion in specialness across lenders for
a given stock at a given point in time.
4
We then examine the relation of this
dispersion to the average specialness in a given day, as well as investigate
other proxies for search costs. In Section III.C, we explore the role played by
alternative nonsearch explanations.
B. The Share Loan Supply Curve
Although search frictions are constant in the DGP model, they are not likely
to be so in practice. As DGPpoint out, these frictions are likely to be close to zero
4
One natural way to understand the DGP model in the context of heterogeneous search costs
is to think in terms of local monopolies. Search frictions give each lender a local monopoly because
borrowers have greater difculty nding lenders competitors. When share loan demand is high,
search frictions increase the monopoly power of lenders. Furthermore, if there is heterogeneity
among lenders, each will have a different monopoly price, so as search frictions increase, we expect
more price dispersion.
Supply and Search in the Equity Lending Market 563
Hedge
Fund 1
Prime
Broker
1
Lender 1
Hedge
Fund 2
Hedge
Fund 3
Hedge
Fund 4
Hedge
Fund N
1
Lender 2
Lender 3
Lender 4
Lender N
3
Prime
Broker
2
Prime
Broker
3
Prime
Broker
N
2
Figure 1. Structure of the equity lending market. Figure 1 presents an example of the
structure of the equity lending market. Hedge funds, shown as Hedge Fund 1 through Hedge Fund
N
1
, can be clients of multiple prime brokers, Prime Broker 1 through Prime Broker N
2
. These prime
brokers can have relationships with multiple securities lenders, Lender 1 through Lender N
3
. The
relationships with these lenders can be regular (bold line), occasional (solid line), or infrequent
(dashed line).
when demand for loans is low. In this case, brokers have more lenders than bor-
rowers among their clients, so matching is nearly costless. In addition, brokers
have the ability to contact different lenders for information about availability
and pricing, and most of the time the lenders with whom they have an existing
relationship have an ample supply of most stocks. However, conversations with
industry participants indicate that certain stocks may not be available from all
lenders, and in these cases we would expect brokers to search for shares. The
existence of third-party lenders, or nders as in Fabozzi (1997), supports this
view. Figure 1 shows the structure of these relationships.
The supply of easily obtainable loans is thus more likely to be exhausted if
there is a large shock to the demand for share loans; in such a case, searching
for shares will become more difcult and costly. Accordingly, just as search
frictions lead to increases in specialness, we expect the share loan supply curve
to have a positive slope when demand is high. On the other hand, if a loan
program for a particular stock involves certain xed costs, then the marginal
cost of share loans is likely decreasing at very low levels of quantity, inducing
a downward slope in the left-hand portion of the share loan supply schedule.
564 The Journal of Finance
R
The presence of xed costs also likely lowers the number of willing lenders
when demand is low, potentially giving these lenders some monopoly power. As
share loan demand increases from very low to moderate levels, we expect the
number of lenders to increase, thereby reducing monopoly power and yielding
a downward slope in the left-hand portion of the share loan supply schedule.
5
Moreover, the existing literature nds that loan rates tend to be lower for large
loans than for small loans (DAvolio (2002), Geczy, Musto, and Reed (2002)). In
other words, the evidence suggests that volume discounting is prevalent in the
equity lending market. Thus, we expect the share loan supply schedule to be
nonmonotonic, with a downward slope at low quantity levels, a relatively at
slope for moderate quantities, and an upward slope at high quantity levels.
C. Alternative Explanations for an Upward Sloping Supply Curve and Loan
Fee Dispersion
In addition to search costs, other economic factors could plausibly explain
both dispersion in loan fees and an upward sloping share loan supply curve.
We describe these alternative hypotheses below and analyze them empirically
in Section III.C.
C.1. Differences in Lender Desirability
Because borrowers are able to borrow from multiple lenders, and because
each lender draws fromportfolios with different characteristics, it is reasonable
to hypothesize that borrowers may prefer some lenders to others. Differences
in lender desirability would lead to differences in the average fees charged by
lenders. Similarly, differences in lender desirability could lead to price disper-
sion, as borrowers pay more to borrow from certain lenders and less to borrow
from others. We refer to this hypothesis as the lender desirability hypothesis.
C.2. Lender of Last Resort
Another possible explanation is that, for a given stock, there is a dominant
lender who has a large proportion, but perhaps not all, of the lendable shares.
Such a lender could act as the lender of last resort. When demand for share
loans is low, the lender of last resort must compete with other lenders. However,
because the competing lenders have a limited inventory, a sufciently large
demand shock could plausibly deplete this inventory, giving the lender of last
resort a monopoly. As a result, we would expect a supply curve that is at at
low levels of quantity, where lenders compete, and then upward sloping once
5
For example, Kaplan, Moskowitz, and Sensoy (2013) conduct an experiment in which they
examine the impact of shifting the supply of shares in the equity lending market by randomly
making available for lending the shares of some of the stocks in an anonymous money managers
portfolio. However, they note that the manager restricted the experiment to only include rms that
were likely to be in high demand at the time the lending program began.
Supply and Search in the Equity Lending Market 565
quantity reaches the point at which the lender of last resort has monopoly
power. If the lender of last resort hypothesis is true, the upward sloping supply
curve is driven more by inventory concentration than by search costs.
C.3. Lender Cost Differences
In Dufe (1996), the supply curve of treasuries available for loan becomes
steep and upward sloping not because of search costs, but because of differences
in the cost of lending among potential lenders. Dufe refers to these costs as
transactions costs, but they could just as easily be interpreted as costs that are
constant for each lender and varying across lenders. Lenders with low costs
provide loans in most scenarios, but lenders with high costs are only willing to
lend when demand shocks drive loan fees to sufciently high levels. In other
words, the fact that we see an increase in the slope of the supply curve may be
a result of differences in lenders costs, not search costs.
II. Data
To test the hypotheses developed above, we use databases from several
different sources. Our principal analyses use two databases containing loan
quantities and lending fees from 12 different equity lenders: the rst contains
transaction-level data over the period September 26, 2003 to May 9, 2007,
and the second contains data at the stock-day level over the period September
26, 2003 to December 31, 2007. In a supplemental analysis, we also examine
the quantity of shares available to be borrowed in the market over the period
January 1, 2007 to December 31, 2009.
A. Loan Quantity and Lending Fees
The data provider for our study is both a market maker in the equity loan
market and a data aggregator for major equity lenders. In its role as a market
maker, the rm intermediates loans by borrowing from one party and lending
to another. As such, our data provider also contributes its own transactions
to the database. More importantly for the purposes of this paper, in its role
as a data aggregator our data provider collects information about equity loan
market conditions from several equity lenders. In particular, the rm provides
current and historical stock loan market rates based on live data feeds from
equity lenders. These lenders contribute current and historical data about their
own loan portfolios in exchange for access to this market-wide information.
Our database consists of historical loan portfolios from 12 lenders. As shown
in Table I, the lenders providing data are direct lenders, agent lenders, retail
brokers, broker-dealers, and hedge funds.
6
The principal owners of the shares
6
Despite the apparent distinction between lender types, our data provider has not provided spe-
cic denitions of these categories. Table I presents the extent of our information on the description
of lenders; any further description of lender types in the paper is not based on information given
by the data provider.
566 The Journal of Finance
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Supply and Search in the Equity Lending Market 567
that are lent (both directly and through agents) are retail brokerages, pension
plans, insurance companies, and mutual funds. These market participants
represent 36% of the securities lenders by number.
7
In most of the analyses
that follow, including the estimation of the supply schedule, we use the sum of
outstanding share loans by all lenders normalized by total shares outstanding
as our measure of market loan quantity.
We use two separate equity lending databases: the rst database comprises
5,042,056 observations of individual loan transactions fromSeptember 26, 2003
to May 9, 2007 and includes the number of shares, the daily loan rate, and sev-
eral identication variables. The loan rate is the interest paid on the borrowers
collateral, also known as the rebate rate. The relative scarcity of a particular
stock is measured in terms of its specialness, or the difference between its loan
rate and the markets prevailing, or benchmark, loan rate. Our data provider
computes specialness at the rm-day level and this variable is contained in
the second database we use, which contains data that has been aggregated
to the rm-day level. In addition to daily specialness, the aggregate database
contains a measure of the daily quantity and several identication variables. It
comprises 1,511,874 observations of loan transactions aggregated to the stock-
day level over the period September 26, 2003 to December 31, 2007. We use this
aggregate data in our analysis of the share loan supply curve (Tables IVVI
below).
As discussed above, the database of individual transactions contains the daily
loan rate. To calculate the dispersion in loan fees (Tables VII and VIII below),
we need a loan-specic measure of specialness. However, each lender may have
a different benchmark rate. Based on DAvolio (2002) and Geczy, Musto, and
Reed (2002), we calculate specialness by taking the benchmark rate to be the
federal funds rate minus a 10 to 20 basis point spread for each lender. We use
the mode of the distribution of loan fees above the federal funds rate to identify
each lenders spread (the difference between the loan rate and the benchmark)
by loan size category.
8
The median spread is 16 basis points, and the spread
has a relatively large range: the 25th percentile is one basis point and the 75th
percentile is 50 basis points. Among loans above $100,000, the interquartile
range is 0 to 25 basis points.
B. Lender Relationships
We also examine the extent to which lenders have relationships with mul-
tiple borrowers. For each stock on each day, we count the number of trans-
actions made by a given lender. Because borrowers consolidate orders to take
advantage of volume discounts and thereby minimize transaction costs, each
7
State Streets publicly available white paper, Securities Lending, Liquidity, and Capital
Market-Based Finance, indicates that there were 33 dealers in the equity lending market as
of 2001.
8
As in DAvolio (2002) and Geczy, Musto, and Reed (2002), loans are categorized as small
(loans below $100,000), medium (loans between $100,000 and $1,000,000), and large (loans above
$1,000,000).
568 The Journal of Finance
R
transaction in a given stock on a given day is likely to represent a unique bor-
rower. The number of transactions for each lender therefore serves as a proxy
for the number of unique borrowers, or relationships, that a lender has on a
given day.
In Table I, we report descriptive statistics on the time series of each lenders
relationships. Interestingly, we nd signicant variation across lenders in the
mean number of relationships, with the average number of relationships per
day ranging between one and 10. Furthermore, there is a dynamic aspect to the
number of relationships: the mean and median are well below the maximum
for most rms. To take one example, for lender #7 the maximum number of
relationships is 232, but the mean number of relationships is only 5.06 and the
median is 2. The disparity we nd between the maximum versus the means
and medians indicates that the number of relationships is not constant, which
is consistent with the idea that borrowers choose to search for stocks only when
the costs of searching are exceeded by the benets of nding loans. Intuitively,
this could mean that borrowers have a few relationships with lenders from
whom they borrow the majority of their shares, but for scarce stocks borrow-
ers search across a large number of potential lenders. We also note that the
cross-sectional variation in the number of relationships documented here is
consistent with heterogeneity in search costs.
C. Data Compilation
For our analysis of the share loan supply curve, we use the aggregate
database, which contains 1,511,874 daily observations on loan fees and quan-
tities. To this data set we add the daily stock price, ask price, bid price, and
shares outstanding for each rm using data from the Center for Research in
Security Prices (CRSP). We also add Federal Funds Rate, which is the effective
federal funds rate from the H.15 statistical release provided by the Federal
Reserve; S&P Price/Earnings, which is dened as the monthly price to earn-
ings ratio for the S&P500 from Compustat; and VIX, which is calculated as
the rolling mean value of the CBOE volatility index for the S&P500 over the
preceding 22 trading days.
We winsorize all variables in the aggregate database at the 1st and 99th
percentiles and we lter our database to include only those rms with at least
250 observations. After this lter is applied, 586,435 observations remain in
the database. In Table II we report summary statistics for the nal sample.
Although the average value of Specialness is only 37 basis points, it has a
standard deviation of 1.36 and it is highly right-skewed, with a skewness of
5.86. In addition, Loan Quantity as a percentage of shares outstanding is also
highly right skewed.
III. Results
Our primary goal is to understand empirical patterns in the equity loan
market, and measure the extent to which these patterns can be explained
Supply and Search in the Equity Lending Market 569
Table II
Summary Statistics of Instruments and Short Sale Variables
Table II contains summary statistics for the aggregate-level database, which contains 586,435
observations at the rm-day level for the period September 26, 2003 to December 31, 2007. The
database is ltered to include only those rms with more than 250 observations. Discretionary
Accruals is calculated quarterly as in Sloan (1996). Short (Long) Bollinger is an indicator variable
that takes the value one if a stocks price is more than two standard deviations above (below) the
20-day moving average price and zero otherwise. Market Capitalization, in billions, is from CRSP.
News Sentiment is a numerical score based on textual analysis of publicly released rm-specic
news articles, where low (high) scores indicate negative (positive) news. Short-Term Momentum is
the raw buy-and-hold return of a stock over the previous ve trading days and Long-Term Momen-
tum is the one-year momentum factor as in Carhart (1997). Loan Quantity / Shares Outstanding
is the quantity of shares borrowed divided by the number of shares outstanding each day for each
rm. Specialness, in percent, is a measure of the cost of borrowing a stock and is calculated as the
difference between the rebate rate for a specic loan and the prevailing market rebate rate. Federal
Funds Rate is the effective rate available in the H.15 statistical release from the Federal Reserve.
S&P Price/Earnings is the monthly price to earnings ratio for the S&P500 fromCompustat. VIX is
the rolling mean value of the CBOE volatility index for the S&P500 over the preceding 22 trading
days. All variables are winsorized at the 1st and 99th percentiles.
Standard
Variable N Mean Median Deviation Skewness
Panel A: Firm
Discretionary accruals 8,925 0.060 0.004 0.849 20.076
Short Bollinger 530,363 0.097 0.000 0.295 2.731
Long Bollinger 530,363 0.071 0.000 0.256 3.347
Market capitalization
(in $ Billions)
578,018 12.515 3.558 30.749 6.544
News sentiment 528,379 0.004 0.000 0.042 0.440
Short-term momentum 525,260 0.004 0.003 0.055 0.003
Long-term momentum 529,915 0.156 0.149 0.310 0.119
Panel B: Short Sale Transactions
Aggregate specialness
(in percent)
586,435 0.373 0.042 1.366 5.860
Loan quantity/shares
outstanding
578,022 0.049% 0.011% 0.161% 7.542%
Panel C: Macro
Federal funds rate (in percent) 1,558 3.471 3.990 1.647 0.359
S&P price/earnings 52 2.946 2.924 0.118 2.814
VIX 1,073 14.824 14.136 3.366 10.541
by search cost models. First, we estimate the share loan supply curve and
show that search costs are closely connected to its shape. Next, we empirically
verify that the generic predictions of sequential search cost models hold for
the equity loan marketthat is, that search costs are positively correlated
with price dispersion and the level of prices. Finally, we explore other possible
explanations for the empirical patterns we nd.
570 The Journal of Finance
R
0.78
0.83
0.88
0.93
0.98
1.03
1.08
1 2 3 4 5 6 7 8 9 10
S
p
e
c
i
a
l
n
e
s
s
Trade Quantity / Outstanding Shares
(grouped into deciles)
Mean 95% Confidence Interval
Figure 2. Specialness as a function of trade quantity in 2006. Trade quantity is divided by
outstanding shares to account for persistent differences in loan quantities across securities. For
each rm, these relative quantities are then assigned to a decile based on their position relative
to other trade quantities for that rm and year. The gure plots the mean specialness across all
rms for each decile. Specialness, in percent, is a measure of the cost of borrowing a stock and is
calculated as the difference between the rebate rate for a specic loan and the prevailing market
rebate rate. The rebate rate for an equity loan is the rate at which interest on collateral is rebated
back to the borrower.
A. Modeling the Share Loan Supply Curve
Presumably, short sale constraints arise as short sellers demand for share
loans increases.
9
However, not all increases in share loan demand lead to
increases in loan fees (Christoffersen et al. (2007)). So the question remains,
by how much does demand need to increase before loan fees increase?
As a rst pass, in Figure 2 we conduct a simple experiment, modeled on
that of DAvolio (2002), in which we plot specialness (or excess loan fee) as a
function of quantity loaned. To account for persistent differences in loan quan-
tity across securities, we calculate relative quantity loaned. In other words,
quantity is measured as the rank of normalized loan quantity, dened as the
number of shares lent divided by total shares outstanding. We nd that spe-
cialness declines mildly in loan quantity at low levels of loan quantity, but
when loan quantity is above the 70th percentile, specialness increases sharply
in loan quantity. The changing sensitivity of specialness to quantity has prac-
tical importance for borrowers: upward shifts in the quantity demanded do not
necessarily increase loan prices and may even decrease them in some cases.
9
DAvolio (2002) shows a positive correlation between short interest and loan fees.
Supply and Search in the Equity Lending Market 571
This initial approach is inherently limited, however. The supply schedule
cannot be mapped out correctly using prices and quantities unless the supply
curve does not shift during the measurement period. To trace out the supply
curve more carefully, we turn to a two-stage regression approach, similar to
that of Angrist, Graddy, and Imbens (2000). Specically, we use exogenous
shifts in the demand for equity loans as a means to identify the supply curve.
As discussed inSectionI.B, economic theory suggests that the share loansupply
curve may not be linear. To allow for this possibility, we employ a nonlinear
technique that builds on the linear approach of Angrist, Graddy, and Imbens
(2000).
In Subsection A.1 below, we use economic theory to propose several instru-
ments for share loan demand and then conduct an empirical falsication test
of their validity. In Subsection A.2 we describe our technique for estimating the
share loan supply curve and we present our results. Finally, in Subsection A.3,
we examine how the shape of the supply curve differs for rms with different
search cost characteristics.
A.1. Instruments for Share Loan Demand
To identify the share loan supply schedule, we must use variables that affect
the demand for loans but not the supply. Prior research suggests that most
of the supply of shares available for loan comes from institutions with stable,
low-turnover portfolios (e.g., DAvolio (2002)). On the other hand, the literature
has shown that many short sellers have relatively short time horizons.
10
Thus,
one category of potentially valid instruments includes variables that are re-
lated to short-term trading strategies but not long-term trading strategies. It
stands to reason that low-turnover institutions are, by denition, not concerned
with the shorter term components of price movements. Accordingly, variables
that isolate the short-term components of price uctuations are likely to make
valid instruments, consistent with Boehmer, Jones, and Zhangs (2008, p. 498)
nding that . . . short selling is dominated by short-term trading strategies.
Accordingly, in what follows below we dene and discuss ve candidate in-
struments that are likely to affect the demand for loans but not the supply:
News Sentiment, Short-Term Momentum, Short Bollinger, Long Bollinger, and
Discretionary Accruals.
One variable that is likely to impact the strategies of short sellers but not
the strategies of low-turnover institutions is daily News Sentiment, which is a
measure of the amount of positive or negative information contained in pub-
licly released rm-specic news articles. Low-turnover institutions (i.e., equity
lenders) are unlikely to trade every time there is a news article about one of
the stocks in their portfolio. On the other hand, Engelberg, Reed, and Ringgen-
berg (2012) and Fox, Glosten, and Tetlock (2010) show that short sellers do
respond to daily news events. Accordingly, we consider News Sentiment as
10
Geczy, Musto, and Reed (2002) show that the median duration of a stock loan is three trading
days, and Diether (2008) nds the median short position is held for 11 trading days.
572 The Journal of Finance
R
a potential instrument for share lending demand, where News Sentiment is
dened for each rm and day as a numerical score between 1 and 1; low
scores indicate negative news and high scores indicate positive news. The news
data come from RavenPack, Inc., a leading provider of news analytics data for
use in quantitative and algorithmic trading. In the normal course of its busi-
ness, RavenPack uses proprietary algorithms to process news articles and press
releases into machine-readable content and the data used in this study are de-
rived from all news articles and press releases that appeared in the Dow Jones
newswire, which includes, among other sources, the Wall Street Journal and
Barrons.
We also consider variables that capture the short-term component of price
uctuations. Specically, we consider several variables related to technical
analysis. Survey evidence suggests that institutional portfolio managers use
technical trading rules when their time horizons are short (weeks), but not
when their time horizons are long (e.g., Carter and Van Auken (1990), Menkhoff
(2010)). Accordingly, we consider Short-Term Momentum as an instrument,
where Short-Term Momentum is dened as the raw buy-and-hold return of
a stock over the previous ve trading days. Diether, Lee, and Werner (2010)
show that short sellers do respond to short-term momentum; however, it is
unlikely that low-turnover institutions, which provide the bulk of lendable
shares, respond to it. To make sure our short-term measures of returns are
isolating the high-frequency component of price movement, we also include
Long-Term Momentum as a control variable, where Long-Term Momentum is
dened as the traditional one-year momentum factor as in Carhart (1997).
In addition, we use another technical trading rule, namely, Bollinger bands
(Bollinger (2002)), to motivate two additional candidate instruments. Speci-
cally, the Bollinger band strategy prescribes going short and long when a stock
price is respectively above or belowits 20-day moving average by more than two
standard deviations.
11
We use the rule to dene the indicator variables Short
Bollinger and Long Bollinger, where Short Bollinger and Long Bollinger equal
one when a stock is respectively above or below its 20-day moving average by
more than two standard deviations and zero otherwise.
Finally, we consider Discretionary Accruals, as computed in Sloan (1996), as
a potential instrument. Discretionary accruals constitute a decision by man-
agement to shift earnings from one period to another. Thus, high or low dis-
cretionary accruals cannot persist and must, by construction, be followed by
a reversal. Recent accounting studies suggest that this reversal occurs in less
than a year, and all the negative (positive) abnormal returns associated with
high (low) discretionary accruals are realized by the time of the accrual re-
versal (e.g., Allen, Larson, and Sloan (2010), Fedyk, Singer, and Sougiannis
(2011)). Discretionary accruals are therefore unlikely to be related to trading
by low-turnover institutions and hence the quantity of lendable shares. On the
other hand, prior literature nds that short selling is related to discretionary
accruals (e.g., Cao et al. (2008)).
11
Technical traders differ on the precise parameters, so we choose a 20-day moving average and
two standard deviation bands because Bollinger designates them as the default (Bollinger (2002)).
Supply and Search in the Equity Lending Market 573
Having made an a priori case for our instruments based on economic theory,
we next conduct a formal empirical falsication test of their validity. For this
test, we use a data set that contains the aggregate number of shares that equity
lenders have available for loan over the period January 1, 2007 to December
31, 2009. We then test whether any of our instruments are signicantly related
to this aggregate quantity of lendable shares. If they are not, we infer that our
instruments meet the exclusion restriction and are unrelated to the quantity
of lendable shares.
The data we use for this test comes from Data Explorers, a leading provider
of data in the equity loan market. Data Explorers aggregates and distributes
information regarding the equity lending market at the daily frequency. The
data are sourced directly from a wide variety of contributing customers in-
cluding benecial owners, hedge funds, investment banks, lending agents, and
prime brokers. The database contains information on the aggregate quantity
lenders actually lend out as well as the aggregate quantity of shares lenders
have available for loan, including those not lent. Our falsication test uses the
quantity available normalized by shares outstanding. We henceforth refer to
this variable as lendable shares.
To conduct our falsication test, we run the following panel data regression
in which the dependent variable is the log of the number of lendable shares
and the independent variables are the candidate instruments discussed above:
Lendable Shares
it
=
1
Accruals
it
+
2
ShortB
it
+
3
LongB
it
+
4
News
it
+
5
STMom
it
+Controls
it
+FE
i
+
it
,
(1)
where Accruals are discretionary accruals, ShortB and LongB are the short
and long Bollinger indicator variables, News is news sentiment, and STMom
is short-term momentum. We include stock xed effects, and we cluster the
standard errors by stock and day to ensure robustness to heteroskedasticity
as well as serial and cross-sectional correlation. If the candidate instruments
meet the exclusion restriction, they should have no explanatory power in this
regression. The results, presented in Table III, are consistent with our a pri-
ori arguments. The coefcients on our candidate instruments (Discretionary
Accruals, Short Bollinger, Long Bollinger, News Sentiment, and Short-Term
Momentum) are individually and jointly statistically indistinguishable from
zero.
In addition to being statistically insignicant, our point estimates suggest
that the effect of our candidate instruments on lendable shares is also econom-
ically negligible. Take, for instance, the coefcient estimate on News Sentiment
of 0.0129. This implies that a one standard deviation increase in News Sen-
timent of 0.042 units shifts the log of lendable shares by 0.0005 [0.0005 =
0.01290.042], a negligible amount compared to the standard deviation of the
log of lendable shares of 0.6952. Other point estimates imply that a one stan-
dard deviation increase in Short-Term Momentum and Discretionary Accruals
impacts lendable shares by the economically negligible amounts of 0.0007
and 0.0002, respectively. Finally, the coefcients on the Bollinger indicator
574 The Journal of Finance
R
Table III
Effect of Candidate Instrumental Variables on the Quantity of
Lendable Shares
Table III displays the results of a panel data regression of Lendable Shares on ve different
candidate instruments for the period January 1, 2007 to December 31, 2009 of the form
Lendable Shares
it
=
1
Accruals
it
+
2
ShortB
it
+
3
LongB
it
+
4
News
it
+
5
STMom
it
+Controls+FE
i
+
it
.
Lendable Shares is the natural log of the number of shares available for loan each rm and day as
a percentage of shares outstanding. The candidate instruments are described in detail in Section
III.A of the text. Federal Funds Rate is the effective federal funds rate as reported by the H.15
statistical release, Long-Term Momentum is the natural log of the one-year momentum factor
as in Carhart (1997), S&P Price/Earnings is the natural log of the S&P500 price to earnings
ratio for the preceding month, and VIX is the rolling mean value of the CBOE volatility index
for the S&P500 over the preceding 22 trading days. Firm xed effects are included and F-Test of
Instruments assesses whether the candidate instruments are jointly different from zero. Robust
standard errors clustered by rm and date are below the parameter estimates in parentheses.

indicates signicance at the 1% level,



indicates signicance at the 5% level, and

indicates
signicance at the 10% level.
Explanatory Variable Dependent Variable: Lendable Shares
Discretionary accruals 0.0002
(0.02)
Short Bollinger 0.0012
(0.00)
Long Bollinger 0.0032
(0.00)
News sentiment 0.0129
(0.02)
Short-term momentum 0.0125
(0.02)
Federal funds rate 0.0097
(0.01)
Long-term momentum 0.0232

(0.01)
S&P price/earnings 0.0387

(0.01)
VIX 0.0005
(0.00)
Firm xed effect Yes
N 642,134
F-test of instruments 2.02
P-value 0.85
R
2
0.02
variables imply that a stock price movement from within the Bollinger bands
to a point above or below them impacts the quantity of lendable shares by a
negligible 0.0012 and 0.0032, respectively. Accordingly, because the candidate
instruments are both statistically and economically insignicant in the falsi-
cation test, we adopt Discretionary Accruals, Short Bollinger, Long Bollinger,
Supply and Search in the Equity Lending Market 575
News Sentiment, and Short-Term Momentum as instruments in the estimation
of the supply curve.
A.2. Estimating the Share Loan Supply Schedule
Using the instruments discussed above, we estimate the share loan supply
curve, which allows us to determine the inuence of short sellers demand for
share loans on specialness and the extent to which increases in loan prices are
related to search frictions. We discuss our estimation procedure in detail below.
To ensure comparability across stocks, we standardize our loan quantity vari-
able. First, we divide quantity by total shares outstanding for each stock. This
removes the effect of stock price on quantity, which would likely be sufcient for
an estimation using market-wide quantity. However, because our lenders hold
only a segment of the quantity of lendable shares of each stock, and because
that segment may vary by stock, we need to further normalize each stocks
quantity. Thus, we standardize each stocks quantity variable by subtracting
the mean and dividing by the standard deviation of each stocks loan quantity
as a percentage of shares outstanding. We denote this standardized value of
share loan quantity by Q.
Next, we need to take into consideration the highly skewed nature of both
quantity and specialness, as well as the probable nonlinearity of the supply
curve. To this end, we employ a trans-log specication in which we model the
started natural log of specialness as a function of the started natural log of
quantity demanded and its square.
12
Greene (1997) notes that this sort of
specication is highly exible and can be interpreted as a second-order ap-
proximation of virtually any smooth functional form. Using the instruments
discussed above, we thus represent the share loan demand and supply sched-
ules as the following limited information system, with the supply schedule (3)
as the identied equation:
LN(Q
it
+C) =
i
+
1
LN(S
it
+D) +
2
Accruals
it
+
3
ShortB
it
+
4
LongB
it
+
5
News
it
+
6
STMom
it
+Controls
it
+
it
(2)
LN(S
it
+ D) =
i
+
1
LN(Q
it
+C) +
2
LN(Q
it
+C)
2
+Controls
it
+
it
, (3)
where C and D are start constants that ensure the log is dened,
13
Q is loan
quantity, S is specialness, Accruals are Discretionary Accruals, ShortB and
LongB are the Short and Long Bollinger indicator variables, News is News
Sentiment, and STMom is Short-Term Momentum, all as dened above. The
Controls vector includes the federal funds rate, long-term(365 day) momentum,
the level of the VIX index, and the P/E ratio of the S&P500. We also employ
12
Since our quantity variable is standardized to make it comparable across stocks, it can take
negative values. Likewise, specialness can be negative. Therefore, as Fox (1997) suggests for right-
skewed variables with negative values, we use the started log transformation of both quantity and
specialness. Our results are not sensitive to the choice of start constant.
13
We use start constants C = 10 and D = 1, but our results are not sensitive to different values.
576 The Journal of Finance
R
Table IV
First-Stage Estimation of the Share Loan Supply Curve
Table IV presents the rst-stage results from a two-stage instrumental variables panel data re-
gression of daily data over the period September 26, 2003 to December 31, 2007. The excluded
instruments are discussed in Section III.A of the text and, because there are two endogenous re-
gressors (the started log quantity and its square), there are two rst-stage regressions. Firm xed
effects are included in all models. The F-statistic tests the null of weak identication. Robust stan-
dard errors clustered by rm and date are shown below the parameter estimates in parentheses.

indicates signicance at the 1% level,



indicates signicance at the 5% level, and

indicates
signicance at the 10% level.
Dependent Variable
Explanatory Variable LN(Quantity + C) LN(Quantity + C)
2
Discretionary accruals 0.0028 0.4056
(0.00) (0.32)
Short Bollinger 0.0017

0.2395
(0.00) (0.19)
Long Bollinger 0.0004 0.0575
(0.00) (0.05)
News sentiment 0.0101

1.4461
(0.01) (1.15)
Short-term momentum 0.0216

3.0968
(0.01) (2.46)

(Quantity +C)
2
32.2487
(24.78)
Federal funds rate 0.0024

0.3487
(0.00) (0.28)
Long-term momentum 0.0018 0.2544
(0.00) (0.20)
S&P price/earnings 0.0140 2.0318
(0.01) (1.62)
VIX 0.0030

0.4298
(0.00) (0.34)
Firm xed effect Yes Yes
N 508,744 508,744
F-test of excluded instruments 5.50

5.52

P-value 0.0000 0.0000


stock xed effects. We estimate equation (3) for a panel of stock-days over the
period September 26, 2003 to December 31, 2007 using the nonlinear two-stage
least squares procedure suggested by Wooldridge (2002).
14
For robustness, we
also estimate the equation using limited-information maximum likelihood and
Fuller-k methods. The results from the rst-stage regression, including a test
of weak identication, are reported in Table IV. Our results from estimating
equation (3), the supply curve, along with additional specication tests, are
presented in Table V.
14
We stress that we are not running what Wooldridge (2002, p. 236237) calls the forbidden
regression, but rather the more involved, unbiased procedure he describes.
Supply and Search in the Equity Lending Market 577
Table V
Second-Stage Estimation of the Share Loan Supply Curve.
Table V presents the second-stage results from a panel data regression of the started natural log of
loan fee (Specialness + D), on the started natural log of quantity (Q + C), according to the model:
LN(Specialness
i,t
+ D) =
1

LN(Q
i,t
+C) +
2

LN(Q
i,t
+C)
2
+
4

n=1

n+2
Control
n,i,t
+FE
i
+
it
,
where

LN(Q+C) and

LN(Q+C)
2
are the tted values from the rst-stage regressions shown in
Table IV. Results below use C = 10 and D = 1, but are unchanged if we use other start constants.
Federal Funds Rate is the effective federal funds rate as reported by the H.15 statistical release,
Long-Term Momentum is the natural log of the one-year momentum factor as in Carhart (1997),
S&P Price/Earnings is the natural log of the S&P500 price to earnings ratio for the preceding
month, and VIX is the rolling mean value of the CBOE volatility index for the S&P500 over the
preceding 22 trading days. All variables are measured over the period September 26, 2003 to
December 31, 2007. Firm xed effects are included in all models and estimation is done using
three different estimators (2SLS, Fuller, and LIML). Robust standard errors clustered by rm and
date are shown below the parameter estimates in parentheses.

indicates signicance at the 1%
level,

indicates signicance at the 5% level, and

indicates signicance at the 10% level.
Estimation Method
Explanatory Variable (1) 2SLS (2) Fuller (3) LIML
LN(Quantity + C) 295.6990

403.3024

411.4129

(58.93) (110.30) (114.98)


LN(Quantity + C)
2
61.1657

83.8573

85.5697

(12.33) (23.23) (24.22)


Federal funds rate 0.0889

0.1091

0.1107

(0.02) (0.03) (0.03)


Long-term momentum 0.1358

0.1736

0.1764

(0.04) (0.05) (0.05)


S&P price/earnings 0.2588 0.4758 0.4923
(0.21) (0.33) (0.35)
VIX 0.0162

0.0185 0.0186
(0.01) (0.01) (0.01)
Firm xed effect Yes Yes Yes
N 508,744 508,744 508,744
Kleibergen-Paap rK LM statistic 25.263 25.263 25.263
P-value 0.0001 0.0001 0.0001
Cragg-Donald Wald F-statistic 10.394 10.394 10.394
Sargan-Hansen statistic 5.885 3.721 3.606
P-value 0.2079 0.4451 0.4619
As can be seen in Table V, the log of quantity and its square are strongly
signicant in all specications, implying that exogenous shifts in quantity de-
manded impact specialness. Note that the parameters are qualitatively simi-
lar across the three different estimation methods. Moreover, the specications
tests shown in Tables IV and V indicate that our instruments satisfy the ex-
clusion restrictions and that weak instrument bias is not a concern.
To examine the economic signicance of these results, Figure 3 plots the
supply curve for the average stock as implied by our two-stage least squares
parameter estimates. Consistent with the nding in Christoffersen et al. (2007)
578 The Journal of Finance
R
-10.0
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
80.0
-0.8 -0.2 0.3 0.9 1.5 2.1 2.7 3.3 3.9 4.5
S
p
e
c
i
a
l
n
e
s
s
Standardized Loan Quantity
Figure 3. The share loan supply curve. Figure 3 shows the price of borrowing a share (Spe-
cialness) as a function of the quantity (Standardized Loan Quantity) using the coefcient estimates
shown in Table V. Standardized Loan Quantity is the quantity of shares borrowed divided by the
number of shares outstanding, demeaned and normalized by the standard deviation to account for
persistent differences in loan quantities across securities. Specialness, in basis points, is a measure
of the cost of borrowing a stock and is calculated as the difference between the rebate rate for a
specic loan and the prevailing market rebate rate. The rebate rate for an equity loan is the rate at
which interest on collateral is rebated back to the borrower. Details on the supply curve estimation
technique are presented in Section III.A of the text. The gure displays the results from a 2SLS
regression of LN(Specialness + D) as a function of LN(Standardized Loan Quantity + C), where
C and D are start constants suggested by Fox (1997) to ensure the LN function is dened for all
observations. Results are shown for C = 10 and D = 1, but the results are not sensitive to start
constant values. We retransform the estimates to display Specialness as a function of Standard-
ized Loan Quantity. The gure is plotted between the 1st and the 99th percentiles of Standardized
Loan Quantity.
that lending fees are relatively unresponsive to increases in quantity, the sup-
ply curve is at throughout most of the distribution. However, Figure 3 shows
that at lowand high quantity levels, the curve exhibits a U-shape. At lowlevels
of quantity the curve exhibits a slight downward slope, consistent with xed
lending costs and volume discounting. On the other hand, at high levels of quan-
tity the curve exhibits a steep upward slope, consistent with the search cost
hypothesis and the ndings of Cohen, Diether, and Malloy (2007). As shown in
Figure 3, a one standard deviation increase from the third to fourth standard
deviation of quantity is associated with a movement in abnormal loan fees from
3.2 basis points to 21.7 basis points. Thus, the results help reconcile seemingly
contradictory ndings in the extant literature regarding the existence of both
small and large effects of shifts in demand on price, and provide new evidence
that search costs give equity lenders the ability to charge higher prices.
Supply and Search in the Equity Lending Market 579
A.3. Cross-Sectional Patterns in Supply Curves
Given our ndings above about the shape of the share loan supply curve, we
next examine the importance of search costs in determining the supply curves
shape. Specically, we compare the shape of the supply curve for subsamples
of stocks likely to have different search costs. DGP suggest that search costs
are likely to be higher for small rms and illiquid rms, so we use Market Cap-
italization and Bid-Ask Spread, both calculated using daily data from CRSP,
as two of the measures on which we create subsamples. Interestingly, rm size
and liquidity may also affect the shape of the supply curve under alternative
explanations, so these two variables do not provide sharp distinctions between
possible explanations.
We also use two search cost proxies related to the structure of the equity
lending market that take advantage of the richness of our multiple lender
data set. If nding lenders is costly, and smaller lenders are more difcult
to nd than large lenders, we expect search costs to be higher in equity loan
markets that tend to be fragmented among many small lenders. Unlike size
and liquidity, these proxies give us more traction in distinguishing various
possible explanations, which we more fully discuss in Section III.C.
The rst of our market structurerelated search cost proxies is based on loan
volume concentration. In the DGP model, agents are randomly matched with
search intensity and, all else equal, a lower search intensity leads to higher
loan fees because it is more costly for agents to match. In practice, if the loan
market is highly fragmented and no lender holds a signicant amount of shares,
it is likely that matching will be costlier. Accordingly, for each stock and each
week, we compute the total loan volume for each lender as a fraction of shares
outstanding and we use this measure to compute a Herndahl index.
15
Next
we compute the time-series average of this index for a given stock and refer
to it as Lender Volume Concentration. Small values of this variable indicate
that, for a typical week, lending in a given stock tends to be disbursed among
many lenders with low volume, suggesting the market tends to be fragmented
among many lenders with low levels of volume. If search costs are important in
this market, and search costs play a role in shaping the supply curve, then we
expect low values of Lender Volume Concentration to be associated with higher
supply curve slope coefcients.
Our second market structurerelated search cost proxy is based on the num-
ber of lenders active in a stock on a typical week as well as a proxy for lender
size. To construct this measure, for each stock we compute the time-series
average loan size of each lender (as a percentage of shares outstanding) and
compare it to the average loan size across all lenders in the stock. If a lenders
average loan size is smaller than the average for all lenders in the stock, we
refer to that lender as small. Otherwise the lender is large. Next, for each
stock week, we count the number of small and large lenders and take the
time-series averages for the stock and label these averages as Number Small
15
We compute the index by week instead of by day because some stocks have many days for
which there is very little trading activity.
580 The Journal of Finance
R
Lenders and Number Large Lenders, respectively. The number of small lenders
thus measures the extent to which a stocks share loan market tends to be
fragmented among many lenders with smaller-than-average volume. If search
costs play an important role in shaping the supply curve, we expect the slope
of the curve to be larger when Number Small Lenders is higher. On the other
hand, if large lenders are easier to nd, we expect search costs to be lower when
Number Large Lenders is high.
To test whether the shape of the supply curve is different for rms with dif-
ferent search cost characteristics, we compute the sample medians of Market
Capitalization, Bid-Ask Spread, Lender Volume Concentration, Number Small
Lenders, and Number Large Lenders. For each of these characteristics, we then
create two subsamples of stocks: low and high, where the low (high) subsample
includes all rms with values below (above) the median of the relevant charac-
teristic. We then reestimate the supply curve, allowing its parameters to differ
across subsamples, and then conduct Wald tests of the null hypothesis that
they do not differ.
The results are reported in Table VI . We nd that the parameters of the
supply curve are statistically different for all measures of search costs, includ-
ing Market Capitalization, Bid-Ask Spread, Lender Volume Concentration, as
well as Number Small Lenders, and Number Large Lenders. Consistent with
the search cost hypothesis, we nd that the coefcient on the quantity squared
term is larger, and hence the supply curve is more steeply upward sloping,
when rms are smaller, when rms are less liquid, and when rms loan vol-
ume is dispersed among many lenders. Interestingly, whereas the results in
Panels A, B, and C strongly support the search cost hypothesis, the results
in Panels C and D are generally weaker. For both Number Small Lenders and
Number Large Lenders, the curves are economically similar across subsamples.
Thus, the results in Table VI generally support the search cost hypothesis,
though not all search cost proxies appear to inuence the shape of the supply
curve.
B. Industrial Organization, Search Costs, and the Equity Loan Market
DGP describe the prevalence of search frictions in the opaque equity lend-
ing market, and in the previous section we present evidence that search fric-
tions inuence the shape of the equity loan supply curve. In this section, we
further examine the role of search costs in the equity loan market by ex-
amining them in light of the industrial organization literature on sequen-
tial search costs. First, in Subsection B.1 we use panel data regressions to
conrm that loan fee dispersion is associated with various proxies for search
frictions as well as the average level of fees. This result conrms the predic-
tion of sequential search models that price dispersion is positively associated
with search frictions. Then, in Subsection B.2, we explore in greater depth
how the loan fee level, or specialness, is a function of the dispersion in loan
fees.
Supply and Search in the Equity Lending Market 581
Table VI
Sensitivity of Share Loan Supply Curve to Firm Characteristics and
Search Cost Proxies
Table VI presents second stage results from six different panel data regressions that estimate the
share loan supply curve. In each panel, we examine the impact that a rmcharacteristic has on the
supply curve by creating two subsamples of stocks, low and high, where the low (high) subsamples
include all rms with values below (above) the median value of the relevant rm characteristic. We
then jointly estimate the supply curve for the low and high subsamples, allowing the parameters
to differ across subsamples, and conduct a Wald test of the null that the subsamples do not differ.
The table displays the results for the LN(Quantity +C) and LN(Quantity +C)
2
parameters for the
low and high rm characteristic subsamples. Market Cap is the average market capitalization for
each rm from CRSP. Bid-Ask Spread is the average bid-ask spread for each stock calculated using
the closing mid-price on each day. Volume Concentration is a Herndahl index using each lenders
daily volume in a stock. # Small (Large) Lenders is the mean number of small (large) lenders that
dealt in a particular stock each week. Capacity Concentration is a Herndahl index using each
lenders maximum possible loan volume in a stock. Robust standard errors clustered by rm and
date are shown below the parameter estimates in parentheses.

indicates signicance at the 1%
level,

indicates signicance at the 5% level, and

indicates signicance at the 10% level.
Subsample LN LN Test Low Firm Fixed
Denition (Qty + C) (Qty + C)
2
versus High Effect N
Panel A: Market Capitalization
Low market cap 232.5745

48.8247

27.60

(70.76) (15.05) (0.00) Yes 508,744


High market cap 186.8668

38.2192

(33.49) (7.23)
Panel B: Bid-Ask Spread
Low bid-ask spread 156.1564

30.6390

18.97

(38.77) (8.16) (0.00) Yes 508,744


High bid-ask spread 235.3641

49.4966

(72.94) (15.48)
Panel C: Lender Volume Concentration
Low volume conc. 211.6295

44.2605

19.61

(37.42) (7.97) (0.00) Yes 507,492


High volume conc. 138.3305

29.0247

(30.28) (6.45)
Panel D: Number Small Lenders
Low # small 249.2926

51.4099

12.29

lenders (64.57) (13.87) (0.06) Yes 507,492


High # small 196.0426

40.6479

lenders (56.33) (11.65)


Panel E: Number Large Lenders
Low # large 139.2103

29.1954

26.11

lenders (27.76) (5.82) (0.00) Yes 507,492


High # large 173.3962

35.9402

lenders (43.34) (9.45)


(continued)
582 The Journal of Finance
R
Table VIContinued
Subsample LN LN Test Low Firm Fixed
Denition (Qty + C) (Qty + C)
2
versus High Effect N
Panel F: Lender Capacity Concentration
Low capacity 299.2151

62.2386

5.58
conc. (119.48) (25.28) (0.47) Yes 507,492
High capacity 328.9796

66.4139

conc. (84.27) (17.19)


B.1. Dispersion and Search Costs
One of the most relevant empirical predictions of sequential search cost
models is that increases in search costs will be associated with increases in
both price dispersion and the average price level. In this section, using search
costs proxies identied in Section III.A.3, we test whether these predictions
hold in the equity lending market.
Our rst task is to compute measures of loan fee dispersion. For each stock-
day we calculate each lenders average specialness. We then dene Cross-
Lender Dispersion as the standard deviation of average lender specialness
across lenders for each stock-day. Because many stocks have a large num-
ber of days with little to no equity lending volume, we compute the weekly
average of Cross-Lender Dispersion, giving us a stock-week panel of obser-
vations. The stock-week is our unit of observation for all tests within this
section.
As search cost proxies, we use the same proxies as in Section III.A.3. Specif-
ically, we use the average Market Capitalization and Bid-Ask Spread for the
week, as well as our weekly measures of Lender Volume Concentration, Num-
ber Small Lenders, and Number Large Lenders. In addition, we use the aver-
age loan fee charged by all lenders in a given week as the level of the loan
fee.
Next, we test the extent to which loan fee dispersion is related to search costs
and the loan fee level by running the following panel data regressions for each
rm i and week t:
Dispersion
it
= +
1
log(MktCap
it
) +
2
Bid Ask Spread
it
+
3
Loan Fee
it
+
4
(LoanFee
it
)
2
+
5
NumberSmallLenders
it
+
6
NumberLargeLenders
it
+
it
(4)
Dispersion
it
= +
1
log(MktCap
it
) +
2
Bid Ask Spread
it
+
3
Loan Fee
it
+
4
(Loan Fee
it
)
2
+
5
Volume Concentration
it
+
it
.
(5)
Supply and Search in the Equity Lending Market 583
We estimate both equations using OLS and include time xed effects with
standard errors clustered by rm.
16
The results, presented in Models 1 and
2 of Table VII, are largely consistent with the prediction that increases in
search costs are associated with increases in price dispersion. We nd that
market capitalization does play a role. The statistically negative coefcient on
log(MktCap) in both model specications indicates that larger rms have less
price dispersion, which is consistent with DAvolio (2002) and Geczy, Musto,
and Reed (2002), who nd that larger rms are more widely held and held
in larger quantities by equity lenders, and as a result, their stock is easier
to borrow. In other words, loans in large, and presumably widely held, stocks
are associated with lower search costs and lower price dispersion. Further evi-
dence for this comes from the coefcients on our two market structure proxies
for search costs, Number Small Lenders and Lender Volume Concentration. In
Models 1 and 2, the two variables have signicant positive and negative coef-
cients, respectively, indicating that fee dispersion is higher when the equity
loan market is fragmented among many small lenders.
We further note that the coefcient on loan fee is positive and signicant in
both model specications, indicating that dispersion increases in the average
fee level, consistent with the predictions of sequential search models in the
industrial organization literature. Because lending fees are highly skewed and
possibly have a larger effect as they reach extreme levels, we also run the
following specication:
Dispersion
it
= +
1
log(MktCap
it
) +
2
Bid Ask Spread
it
+
3
Loan Fee
it
+
4
(Loan Fee
it
)
2
+
5
Volume Concentration
it
+
6
Special Dummy
it
+
7
(Special Dummy
it
Volume Concentration
it
) +
it
,
(6)
where SpecialDummy is an indicator variable that equals one when the loan
fee exceeds 25 basis points and equals zero otherwise.
17
Note that the coef-
cient on SpecialDummy is strongly signicant, which supports the predictions
of the sequential search cost models that, in the presence of search costs, ex-
treme scarcity will be associated with more price dispersion. Note further that
the coefcient on the interaction term between SpecialDummy and Lender
Volume Concentration is strongly negative, which indicates that the effect of
extreme loan fees on dispersion is enhanced when the market for share loans
in a particular stock is fragmented among many small lenders and search costs
16
To ensure that cross-sectional correlation in the error terms is not confounding our inferences,
we also compute standard errors clustered by both rm and time as suggested by Petersen (2009).
As can be seen in the Internet Appendix (available in the online version of this article), the double-
clustered standard errors are not materially different from those we obtain with a single rm
cluster. Hence, we conclude cross-sectional correlation is not important in this context and present
our main results using standard errors clustered by rm.
17
DAvolio (2002) nds that the value-weighted average cost to borrow is 25 basis points per
annum and notes that any stock with a rebate rate below the general collateral rate could be
considered special. Our cutoff of 25 basis points is intended to identify stocks that are generally
more costly to borrow than the typical stock.
584 The Journal of Finance
R
Table VII
Determinants of Price Dispersion
The dependent variable is the standard deviation of the loan fee (specialness). Log(Market Cap-
italization) is the log of market capitalization for each rm from CRSP. Bid-Ask Spread is the
difference between the bid and ask price from CRSP measured as a percentage of the closing
mid-price. Number of Small (Large) Lenders is the number of small (large) lenders that dealt
in a particular stock each week. Volume Concentration is a Herndahl index using each lenders
daily volume in a stock. Special Dummy = 1 if the mean weekly specialness for a stock is 0.25,
and Agent & Brokers Dummy, Agent & Direct Lenders Dummy, and Broker & Direct Lenders
Dummy = 1 if the stock has transactions by lenders of both relevant types during a given week.
All Three Lender Types Dummy = 1 if a stock has transactions by all three lenders types. All data
are weekly; to obtain weekly data from daily observations we use the time-series mean over the
week. Standard errors are reported in parentheses and are clustered by rm with weekly xed ef-
fects. Intercept is the mean of the xed effects.

indicates signicance at the 1% level,

indicates
signicance at the 5% level, and

indicates signicance at the 10% level.
Model
Explanatory Variable (1) (2) (3) (4) (5)
Intercept 0.8845

1.2514

0.3550

0.2875

0.8873

(0.15) (0.16) (0.08) (0.08) (0.15)


Log(market capitalization) 0.0391

0.0293

0.0033 0.0046 0.0392

(0.01) (0.01) (0.00) (0.00) (0.01)


Bid-ask spread 3.0114 3.3303 3.5745 3.9085 3.0260
(4.07) (4.21) (4.40) (4.41) (4.05)
Mean loan fee 0.1954

0.2007

0.0649 0.0645 0.1936

(0.05) (0.04) (0.06) (0.06) (0.05)


Mean loan fee squared 0.0020 0.0022 0.0019 0.0020 0.0020
(0.00) (0.00) (0.00) (0.00) (0.00)
Number of small lenders 0.0340

0.0312

(0.00) (0.00)
Number of large lenders 0.0326

0.0309

(0.00) (0.00)
Volume concentration 0.4526

0.1791

0.0931

(0.05) (0.02) (0.03)


Special dummy 1.7948

1.7957

(0.23) (0.23)
Vol. conc. special dummy 1.1997

1.2063

(0.23) (0.23)
Agent andbrokers dummy 0.0812

0.0927

(0.01) (0.01)
Agent and direct lenders
dummy
0.0446

0.0630

(0.02) (0.02)
Broker and direct lenders
dummy
0.0233

0.0073
(0.01) (0.01)
All three lender types
dummy
0.0489

0.0229
(0.01) (0.02)
Time xed effect Yes Yes Yes Yes Yes
N 118,280 118,280 118,280 118,280 118,280
Adj. R
2
0.23 0.22 0.31 0.31 0.23
Supply and Search in the Equity Lending Market 585
are higher. A clear picture now emerges: as stocks scarcity increases, borrow-
ers are forced to search beyond large lenders, and, because it can be costly
for borrowers to nd smaller lenders, the scarce stocks exhibit increased price
dispersion.
B.2. Specialness and Dispersion
Building on the search cost literatures prediction that price dispersion is
driven by search frictions, we would like to further investigate the functional
relation between specialness and dispersion. A connection between the level of
price dispersion and the cost of borrowing supports the hypothesis that search
frictions drive short sale constraints.
We describe our empirical approach as follows. First we compute Cross-
Lender Dispersion for eachstock every day by computing the standard deviation
of average loan fees across lenders. Next, we assign each stock-day observation
to market-wide specialness deciles, where we use each stocks time series of
market-wide specialness to dene deciles. Finally, we compute, and graph in
Table VIII, the average daily Cross-Lender Dispersion for each specialness
decile. We also compute In-Lender Dispersion, which we dene as follows. First,
for each day and each stock, we compute the standard deviation of the fees that
each lender charges on that day. Next, for each stock-day, we take the average
lender fee standard deviation. Finally, we assign stock-day observations to
market-wide specialness deciles inthe same manner as above, and we graph the
average of In-Lender Dispersion for each decile. In short, In-Lender Dispersion
captures the extent to which lenders charge different prices to different clients.
Interestingly, for Cross-Lender Dispersion the results are not monotonic:
there is a pattern of decreasing dispersion for very low specialness deciles
and then increasing dispersion as specialness goes from moderate to high
(Table VIII, Panel A). However, in the higher deciles, higher levels of price
dispersion are correlated with higher loan fees. Therefore, search frictions
appear to inuence the ability of lenders to charge high lending fees. These
results are statistically signicant in a regression framework. Specically, as
conrmed by the signicantly positive coefcient on Market Specialness Decile
in Model 1 of Panel B and the signicantly positive coefcient on Market Spe-
cialness Decile Squared in Model 2. The result that dispersion is increasing
in specialness is consistent with search models, validating the importance of
search costs in this opaque market. Taken together, the patterns in price dis-
persion across lenders in Subsection B.1, and in this section, provide evidence
that costly search contributes to specialness.
The results for In-Lender Dispersion as a function of specialness also are non-
monotonic (Table VIII, Panel A). There is a pattern of decreasing dispersion
fromlowto moderate specialness deciles, and a pattern of increasing dispersion
from moderate to high specialness deciles. Regression results support this pat-
tern: the square of the market-wide specialness decile is a statistically strong
predictor of In-Lender Dispersion. This pattern is consistent with the notion
that lenders have monopoly power both when scarcity is high and when it is low,
586 The Journal of Finance
R
Table VIII
Price Dispersion
Variations in lending fees (specialness) are calculated as the standard deviation of each lenders
price for a given security and day. Cross-Lender Dispersion is the mean standard deviation of
lenders average prices. Specically, for each stock and day we calculate each lenders mean special-
ness and take the standard deviation of the sample of lenders averages. The standard deviations
are then organized by market-wide specialness deciles and averaged. In-Lender Dispersion is the
standard deviation of a particular lenders loans in each stock every day and we take the aver-
age of these in-lender standard deviations by specialness deciles. For each stock, Lender Volume
Concentration is dened as the sum of squared lender volume as a percentage of total volume.
Panel A shows a graph of cross-lender and in-lender price dispersion as a function of scarcity
(market specialness), while Panel B shows the regression results from models of price dispersion
on market-wide specialness (in deciles). Each regression is run on a rm-by-rm basis and we
present the cross-sectional mean of the resulting estimates as in Coval and Shumway (2005) and
Skoulakis (2006) with the standard errors shown below the parameter estimates in parentheses.
Adj. R
2
is the mean of the adjusted R
2
across all rm-level results.

indicates signicance at the
1% level,

indicates signicance at the 5% level, and

indicates signicance at the 10% level.
Panel A: Cross-Lender and In-Lender Price Dispersion as a Function of Specialness
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
1 2 3 4 5 6 7 8 9 10
Market Specialness Decile
Cross-Lender Dispersion In-Lender Dispersion
Panel B: Price Dispersion Regressions
Dependent variable
Cross-lender dispersion In-lender dispersion
Explanatory
Variable (1) (2) (3) (4)
Intercept 0.4529 2.6990

0.0552 0.0402
(3.07) (1.60) (0.20) (0.37)
Lender volume
concentration
0.5288 3.1551

0.2203 0.2711
(2.93) (1.31) (0.20) (0.37)
Market specialness decile 0.1713

0.0177 0.0217

0.0535

(0.10) (0.10) (0.00) (0.02)


Market specialness decile 0.0183

0.0071

squared (0.00) (0.00)


Adj. R
2
0.24 0.35 0.16 0.25
Supply and Search in the Equity Lending Market 587
and thus under these conditions lenders are better able to price-discriminate.
When scarcity is low, borrowers are not searching for securities and thus are not
comparing prices, so lenders have more pricing power. On the other hand, when
scarcity is high, borrowers face search costs. As the difculty of nding shares
increases, lenders who do make loans have more pricing power. Finally, if mild
scarcity drives borrowers to search around for shares but these borrowers can
easily nd alternatives, the pricing power of the lenders is diminished.
C. Alternative Hypotheses
Although our results on price dispersion and the nonlinear supply curve are
consistent with a search cost explanation, it is plausible that they might be
consistent with the alternative hypotheses described in Section I.C. In this
section we examine the following alternative hypotheses: (1) differences in
lender desirability, (2) lender of last resort, and (3) variation in lending costs.
We nd evidence that the rst of these factors contributes to some of the
empirical patterns we uncover. It cannot, however, explain all of them. As
a result, on balance the evidence suggests that search costs are an impor-
tant factor, but not the only factor, driving empirical patterns in the lending
market.
C.1. Differences in Lender Desirability
Recall from Section I.C that variation in lender desirability, from a bor-
rowers point of view, could plausibly induce dispersion in the fees borrowers
are willing to pay to different lenders. We begin our investigation of this alter-
native explanation for loan fee dispersion by looking at average specialness by
lender type. We group lenders into the categories dened by our data provider:
lenders, broker-dealers, and direct lenders. An overview of the lenders in each
category is presented in Table I, whereas the results broken out by lender cat-
egory are reported in Table IX. We nd that there are signicant differences
among lender categories with direct lenders charging the lowest average spe-
cialness (0.16), and broker-dealers charging the highest (0.65). Although the
descriptions in Table I give an intuitive impression that the direct lenders and
the agent lenders may have more stable loan portfolios than broker-dealers, our
data descriptions provide no direct evidence for this view. It is denitely possi-
ble that other characteristics make broker-dealers more desirable lenders. In
other words, the difference in mean loan fees across lender types is consistent
with the differences in lender desirability hypothesis.
We next investigate the sources of price dispersion while noting the pres-
ence of multiple types of lenders. Specically, Table VII presents results from
a regression of price dispersion on measures of search costs and variables
indicating the participation of multiple lender types for a given stock-day. The
statistically signicant estimate of 0.0489 on the variable All Three Lender
Types Dummy in Model 4 shows that price dispersion is indeed higher when
lenders in different categories are participating simultaneously. Moreover,
588 The Journal of Finance
R
Table IX
Loan Fees by Lender Type
The table examines loan fees (specialness) and lender type. Panel A displays summary statistics
for the level of loan fees and trade quantity for each lender type. For the level of the loan fee and
quantity, the mean is rst calculated at the stock-day level for each lender, and then summary
statistics are calculated across lender types. For the mean, the statistical signicance of the differ-
ence between lenders is assessed using a t-test. For the median, the statistical signicance is not a
test of the difference of medians, but rather a Wilcoxon-MannWhitney test of whether or not the
two samples come from the same distribution. Panel B examines the dispersion of loan fees broken
out by the type of lender(s) participating in the market. Price Dispersion is the time-series average
of the standard deviations of lenders average prices. Specically, for each stock and day, we cal-
culate the lenders average specialness and then take the standard deviation across the sample of
lenders. Dispersion is then calculated as the time-series mean of the standard deviations for each
lender category shown below.

indicates signicance at the 1% level,

indicates signicance at
the 5% level, and

indicates signicance at the 10% level.
Panel A: Level of Loan Fee and Quantity
Loan fee Trade quantity
Lender Type Median Mean Median Mean
Agent lender (1) 0.0000 0.4462 47,000 2,892,561
Broker-dealer (2) 0.0061 0.6522 25,000 613,316
Direct lender (3) 0.0090 0.1608 1,000,000 3,691,838
Difference: 1 versus 2 0.0061

0.2060

22,000

2,279,245

Difference: 1 versus 3 0.0090

0.2854

953,000

799,278

Difference: 2 versus 3 0.0029

0.4914

975,000

3,078,523

Panel B: Dispersion of Loan Fees


Lenders Types Participating in
Market Price dispersion Percent of observations
Agent lender only 0.4471 5.35%
Broker-dealer only 0.7240 65.27%
Direct lender only 0.4510 13.58%
Agent lender and broker-dealer 0.4967 5.33%
Agent lender and direct lender 0.2765 0.63%
Broker-dealer and direct lender 0.2041 8.63%
Agent lender, broker-dealer, and
direct lender
0.3587 1.20%
price dispersion is signicantly higher when the specic combination of Agent
Lenders and Broker-Dealers is in the market and also when Broker-Dealers and
Direct Lenders are both active. Interestingly, price dispersion is signicantly
lower for the specic combination Agent Lenders and Direct Lenders. Nonethe-
less, although differences in lender desirability appear to be a signicant factor
explaining price dispersion, our measure of search costs is still strongly signif-
icant even after controlling for these effects. In other words, both differences
in lender desirability and the presence of search costs play a role in explaining
price dispersion.
Supply and Search in the Equity Lending Market 589
One empirical pattern that cannot be easily explained by differences
in lender desirability is the presence of price dispersion within a given
lender (Table VIII). Unless lender desirability has a component that is
borrower-specic, it is difcult to explain the fact that a single lender charges
different prices to different clients for the same stock on the same day. How-
ever, the fact that each borrower uncovers prices individually gives lenders the
ability to charge different prices to different borrowers. In other words, the
presence of within-lender price dispersion can be explained by the search costs
hypothesis but not the lender desirability hypothesis.
C.2. Lender of Last Resort
As described in Section I.C, it is plausible that much, but not all, of the supply
of lendable shares is concentrated with a single lender of last resort. A suf-
ciently large demand shock could exhaust the inventory of small (competing)
lenders, but not the lender of last resort, giving the latter monopoly power and
inducing a positive relation between loan fee and large exogenous shocks to
demand. To explore this hypothesis, we construct a proxy for the concentration
of lender capacity for each stock in our sample. To compute our proxy, we rst
nd, for each stock-lender combination, the maximum number of shares lent
during the sample period. This maximum is our proxy for a particular lenders
capacity in a given stock. Next, for each stock, we compute the Herndahl index
of lender capacity across the 12 lenders, which we refer to as Lender Capacity
Concentration. This Herndahl index measures the extent to which a given
stocks lending capacity is concentrated in a particular lender.
18
We then test
whether Lender Capacity Concentration is related to the shape of the supply
curve. Specically, we split our sample of stocks according to whether they are
above or below the median for capacity concentration. Then, as we do with
Lender Volume Concentration, we estimate the share loan supply curve for the
two subsamples. If the lender of last resort hypothesis is true, we expect the
curve to be steeper for rms with higher Lender Capacity Concentration.
The results are shown in Panel F of Table VI. Contrary to the lender of last
resort hypothesis, Capacity Concentration does not appear to impact the shape
of the supply curve as the two subsamples are not statistically different. In
fact, the coefcient estimates for both the low and high Capacity Concentration
subsamples are nearly identical to the original estimates for the supply curve
shown in Table V.
19
18
We note that Capacity Concentration is closely related to the Volume Concentration measure
we use to test the search cost hypothesis. However, we believe Capacity Concentration is better
suited to test the lender of last resort hypothesis. High values of Capacity Concentration indicate
that only one or a handful of lenders have a high time-series maximum loan amount, indicating
that borrowers are likely to be forced to go to a single lender when loan quantity demanded reaches
extreme values. High values of Volume Concentration, on the other hand, indicate that in a typical
week only a small number of lenders dominates the market, and it is difcult to see how these
lenders could be considered a last resort.
19
To ensure that the lender of last resort hypothesis is not driving our fee dispersion results,
we reestimate the specications in Table VII adding Lender Capacity Concentration as a control
590 The Journal of Finance
R
C.3. Variation in Lending Costs
Recall from Section I.C that lenders might have different marginal costs.
At low levels of demand, borrowers go to the low cost lenders, but as demand
increases, the lowcost lenders inventory is exhausted and borrowers must go to
higher cost lenders, inducing a positive relation between loan fee and exogenous
demand shocks. Although we cannot directly observe the cost structure of each
lender, the richness of our stock loan database does allow us to examine the
properties of the transactions in which each lender chooses to participate. As
a result, we can use these transactions to look for evidence that the lenders
in our database have signicantly different cost structures. If a lender has
high lending costs, we would expect that lender to lend only when the loan
fee is sufciently high. In other words, we would expect some lenders to have
no transactions volume in stocks with low fees. To test this idea, we examine
the fraction of transaction volume made in high price and low price loans.
As shown in Table X, we nd that the majority of lenders concentrate their
volume in loans with low fees. Moreover, although some lenders do have a
higher percentage of their volume in high fee loans, we nd that low fee loans
still account for a substantial portion of their lending activity. Thus, while there
is some evidence that lending costs impact the number of willing lenders when
demand is low (e.g., Kaplan, Moskowitz, and Sensoy (2013)), the evidence here
strongly suggests that most lenders do not enter the market only when loan
fees become sufciently high.
Nonetheless, it is still possible that loan portfolios appear weighted toward
low fee stocks even when there is an intention to concentrate lending in high
fee stocks. In particular, it may be the case that a small number of high volume
transactions occur at low prices even though the majority of the stocks that
a lender is dealing in are high fee rms. To address this concern, Table XI
examines the mean number of unique stocks lent in each price category by
lender. The results indicate that no lender concentrates on lending in only the
high fee stocks.
C.4. Search Costs vs. the Alternatives
In the analyses above, we examine three alternative hypotheses and nd
some evidence that one of them plays a role in explaining price dispersion; we
nd little evidence that the alternatives explain the shape of the share loan
supply curve. We nd that greater variation in lender type, and hence plausibly
lender desirability, is related to loan fee dispersion across lenders. However,
proxies for search costs continue to be signicantly related to cross-lender fee
dispersion even after controlling for variation in lender type. Furthermore, the
lender desirability hypothesis cannot explain within-lender fee dispersion. We
nd that higher Lender Capacity Concentration is not related to the shape of
variable. As can be seen in the Internet Appendix, the results are unchanged, and Lender Capacity
Concentration does not signicantly affect fee dispersion.
Supply and Search in the Equity Lending Market 591
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592 The Journal of Finance
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Supply and Search in the Equity Lending Market 593


the supply curve, contrary to the lender of last resort hypothesis. Finally, we
fail to nd evidence that some lenders only lend when fees are high, making
it implausible that variation in costs across lenders explains the shape of the
share loan supply curve.
IV. Conclusion
This study provides empirical insight into the economic mechanisms that
give rise to short sale constraints. Conrming a central postulate of DGP,
we nd that search costs play an important role in driving borrowing costs.
Specically, we document a positive relation between price dispersion in lend-
ing fees, the average level of fees, and proxies for search costs. We also show
that the average share loan supply schedule is nonmonotonic: it slopes down-
ward when quantity is low, is essentially at for most of the quantity distri-
bution, and then slopes sharply upward when quantity (and search costs) is
high. We nd further evidence in support of the importance of search costs by
demonstrating that the average loan fee, as well as the extent to which the
fee increases in quantity demanded, is positively related to various proxies
for search costs. Although we nd support for one alternative explanation for
price dispersion in the equity loan market, our proxies for search costs con-
tinue to have signicant explanatory power across a wide range of empirical
tests.
Knowledge about patterns in lending fees has important implications for
investors. Based on our ndings, short sellers will be able to more accurately
predict fees for trades they are considering and better evaluate the competi-
tiveness of fees they have paid in the past. Furthermore, principal owners will
be able to predict the revenue generated from various equity lenders when
considering an equity lending strategy. Similarly, these owners will be able to
better evaluate the performance of existing lending programs.
Our ndings thus suggest that search costs in the equity lending market
represent signicant barriers to short sellers and that, at least theoretically,
a reduction in the barriers would be straightforward. Although recent steps
have restrained short selling, the Securities and Exchange Commission (SEC)
has demonstrated substantial interest in removing barriers to short selling to
increase market quality.
20
Our research suggests search costs are signicant
barriers. To date, the equity loan market remains relatively opaque despite the
increasing accessibility of electronic networks, and search costs could be re-
duced, or possibly eliminated, by the creation of a central reporting mechanism
for share availability and loan pricing.
The key economic insights that arise out of this paper are as follows. First,
as a whole, lenders do indeed benet from an opaque equity lending market.
20
The Security and Exchange Commissions Regulation SHO ended the use of price tests for
short selling after December 2006 (SEC(2007)). Similarly, the SEChighlighted the role of increased
transparency in the Securities Lending and Short Sale Roundtable in 2009 (SEC (2009)). On the
other hand, two measures aimed at stemming the nancial crisis had the effect of restricting short
selling (e.g., Kolasinski, Reed, and Thornock (2012)).
594 The Journal of Finance
R
Second, borrowers difculty in nding shares gives lenders the ability to set
different prices, and to set higher prices. Finally, as a result, one reason the
large and economically important equity loan market remains opaque, despite
increasing transparency in other markets, is that lenders benetsometimes
signicantlyfrom search costs.
Initial submission: March 13, 2009; Final version received: October 8, 2012
Editor: Compbell Harvey
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Supporting Information
Additional Supporting Information may be found in the online version of this
article at the publishers web site:
Appendix S1: Internet Appendix