Matthew Ringgenberg

A Multiple Lender Approach to Understanding Supply and Search in the Equity Lending Market

Using unique data from 12 lenders, we examine how equity lending fees respond to demand shocks. We find that when demand is moderate, fees are largely insensitive to demand shocks. However, at high demand levels, further increases in demand lead to significantly 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 models, we find significant dispersion in loan fees, with this dispersion increasing in loan scarcity and search frictions. Our findings imply that search frictions significantly impact short selling costs.

Short Interest and Aggregate Stock Returns

We show that short interest is arguably the strongest known predictor of aggregate stock returns. It outperforms a host of popular return predictors both in and out of sample, with annual R2 statistics of 12.89% and 13.24%, respectively. In addition, short interest can generate utility gains of over 300 basis points per annum for a mean-variance investor. A vector autoregression decomposition shows that the economic source of short interest’s predictive power stems predominantly from a cash flow channel. Overall, our evidence indicates that short sellers are informed traders who are able to anticipate future aggregate cash flows and associated market returns.

Short Selling Risk

Short sellers face unique risks, such as the risk that stock loans become expensive and the risk that stock loans are recalled. We show that these short selling risks affect prices among the cross-section of stocks. Stocks with more short selling risk have lower returns, less price efficiency, and less short selling.

Price Pressure from Short Selling

Using daily equity lending data, I find that short sales lead to significant price pressure, consistent with inelastic short-term demand curves for stocks. Because short sales and returns are endogenously determined, I use an instrumental variables framework to identify their relation. Specifically, I use exogenous shifts in the lendable supply of shares to identify the impact that short sales have on both the level and volatility of returns. I find a one standard deviation increase in daily short interest is associated with a 12 basis point decrease in returns and a 3.8% increase in log realized volatility. Consistent with theoretical predictions, I find that price pressure from short selling is strongest when demand curves are more likely to be downward sloping as a result of heterogeneous beliefs. The results suggest short sales exert considerable price pressure and may help explain the short interest return anomaly (Boehmer, Jordan, and Huszar (2009)) as well as the excess volatility anomaly (Shiller (1981)).Using a novel database that contains information on the quantity of shares demanded and supplied in the equity lending market, I test a previously unexplored implication that follows from models of heterogeneous beliefs: the idea that short sales lead to increased volatility because they alter the supply of shares in the market. Because short sales and returns are endogenously determined, I use an instrumental variables framework to identify their relation. Specifically, I use shifts in the lendable supply of shares to identify the impact that short sales have on both the level and volatility of returns and I find evidence that short sales lead to higher contemporaneous volatility. Moreover, I find that this effect is strongest when demand curves are more likely to be downward sloping as a result of heterogeneous beliefs, a finding consistent with the predictions of heterogeneous belief models. In other words, I find that when there is disagreement among investors, the trades of short sellers lead to increased volatility. JEL classification: G12

The Economic Impact of Index Investing

We study the impact of index investing on firm performance by examining the link between commodity indices and firms that use index commodities. Around 2004, commodity index investing dramatically increased. This event is referred to as the financialization of commodity markets. Following financialization, firms that use index commodities make worse production decisions, earn 40% lower profits, and have 6% higher costs. Consistent with a feedback channel in which market participants learn from prices, our results suggest that index investing distorts the price signal, thereby generating a negative externality that impedes firms’ ability to make production decisions. Received March 31, 2017; editorial decision July 5, 2018 by Editor Itay Goldstein. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

The Information in Fire Sales

Asset prices remain depressed for prolonged periods of time following mutual fund fire sales. We show that this price pressure from fire sales is partly due to asymmetric information which leads to an adverse selection problem for arbitrageurs. After a flow shock, fund managers choose to sell low-quality stocks. To measure this, we use short interest as a proxy variable for the unobservable negative signal managers use when selling. Following flow shocks, managers are significantly more likely to sell stocks which, ex ante, have high short interest. Moreover, these stocks experience future price drops that do not later reverse. In other words, fund managers have stock selling ability. Our findings suggest an explanation for the tendency of asset prices to remain depressed following fire sales: information asymmetries make it difficult for arbitrageurs to disentangle pure price pressure from negative information.

An Information Factor: Can Informed Traders Make Abnormal Profits?

We construct an information factor (INFO) using the informed stock buying of corporate insiders and the informed selling of short sellers and option traders. INFO strongly predicts future stock returns -- a long-short portfolio formed on INFO earns monthly alphas of 1.24%, substantially outperforming existing strategies including momentum. INFO explains hedge fund returns in the time-series and cross-section. Higher values of INFO are associated with increases in aggregate hedge fund value. Moreover, funds with higher covariation between their returns and INFO outperform by 0.28% per month. The results show information processing skill is an important source of return variation.

On Index Investing

We empirically examine the effects of index investing using predictions derived from a Grossman-Stiglitz framework. An increase in index investing leads to lower information production as measured by Google searches, EDGAR views, and analyst reports, yet price informativeness remains unchanged. The findings are consistent with an equilibrium in which investors choose to be informed active traders whenever it is profitable. As index investing increases there are fewer informed active investors (so aggregate information production drops), but the remaining mix of informed and uninformed active investors adjusts until the returns to active investing are unchanged -- thus price informativeness is unchanged.

The Causal Impact of Market Fragmentation on Liquidity

U.S. equity exchanges have experienced a dramatic increase in competition from new entrants, resulting in the fragmentation of trading across different trading centers. Theoretically, more exchange competition should reduce trading costs, yet it may also generate negative network externalities, reducing market quality. We document evidence of both effects using a difference-in-differences and an instrumental variables approach. We find fragmentation improves market quality for liquid stocks while illiquid stocks experience relatively worse quality. Moreover, fragmentation generates pick-off risk that changes how traders behave. Our findings show that market design has important effects on trading behavior and market quality.