Nº 20-69: Securities Lending and Information Transmission: a Model of Endogenous Short-Sale Constraint

I study short-sale constraints in a market with asymmetric information. This paper offers a novel approach endogenizing short-sale constraints by including an asset- borrowing market in the model. Short-sellers have to borrow an asset and therefore reveal information to a lender. The lender trades on her own account in addition to charging fees, which creates an incentive for the short-seller to hide the information and eventually hinders short sales. Ultimately, in a setting à la Kyle, I analyze an equilibrium involving an informed agent, a lender, and a market maker. The model has new implications for profit distribution, market efficiency, and volatility.