Equity Lender Base and Limits to Arbitrage

Using new data on mutual funds’ equity lending positions, we find that short sellers borrow shares from a small set of repeated lenders and the composition of lenders differs from stock to stock. We argue that this fragmented, persistent lender base is driven by investors’ inelastic lending supply, which contributes to limits-to-arbitrage. When existing lenders sell their shares, short sellers struggle to find replacement lenders and get squeezed, even when conventional measures suggest lending supply is slack. Consequently, lending fees spike, and stocks become more likely to be overpriced. Ex ante, risks implied by lender base are priced in equity prices.