Short-Selling Restrictions and Returns: a Natural Experiment

We estimate the causal impact of short-selling restrictions on returns. We take advantage of a unique dataset and exploit a source of exogenous variation in loan fees provided by a tax-arbitrage opportunity that existed in... [ view full abstract ]

We estimate the causal impact of short-selling restrictions on returns. We take advantage of a unique dataset and exploit a source of exogenous variation in loan fees provided by a tax-arbitrage opportunity that existed in Brazil from 1995-2015. The tax-arbitrage opportunity stems from the fact that domestic mutual funds were exempted from income taxes on dividends received by stocks they borrowed, whereas the original owner would be taxed if she did not lend out the stock. Because we observe all equity loan transactions and transacting parts investor identity, we can distinguish equity lending motivated by tax-arbitrage from speculative transactions according to the borrower-lender match. We show that the loan fee on tax-motivated transactions is a source of exogenous variation to estimate the causal impact of the (endogenous) loan fee on stock prices. We find that increases in stock loan fees have strong impact on stock prices.