Securities Lending, Shorting, and Pricing

We present a model of asset valuation in which short-selling is achieved by searching for security lenders and by bargaining over the terms of the lending fee. If lendable securities are difficult to locate, then the price of the security is initially elevated, and expected to decline over time. This price decline is to be anticipated, for example, after an initial public offering (IPO), among other cases, and is increasing in the degree of heterogeneity of beliefs of investors about the likely future value of the security. The prospect of lending fees may push the initial price of a security above even the most optimistic buyer’s valuation of the security’s future dividends. A higher price can thus be obtained with some shorting than if shorting is disallowed. ∗Duffie and Gârleanu are at the Graduate School of Business, Stanford University, Stanford, CA 94305-5015. Pedersen is at the Stern School of Business, New York University, 44 West Fourth Street, Suite 9-190, New York, NY 10012-1126. Emails: [email protected], [email protected], and [email protected]. We are extremely grateful for conversations with Jenny Berd, Gary Klahr, and Bryan Schultz of Goldman Sachs, David Modest of Morgan Stanley, as well as Chris Geczy, Bob Jarrow, David Musto, Eli Ofek, Adam Reed, and members of the Stanford, especially Anat Admati, Peter DeMarzo, Harrison Hong, Ilan Kremer, David Kreps, John Roberts, and Steve Tadelis, as well as referees and particpants at seminar presentations.