Need-for-Hedge : How Does Put Warrant Short-Sell Hedging Intensity Affect Equity Lending Market Dynamics?

We utilize a novel data panel of institutional short-sell transactions (with identification flags for hedgers and non-hedgers), equity covered put warrant data, and securities lending data based on the Taiwan market to show that put warrant derivatives hedge re-balancing raises borrowing costs (loan fees). The short-sell hedging demand is inelastic to fees. The positive fee effect with increased hedging becomes significantly strong for expensive-to-borrow stocks that have liquid at-the-the-money warrants. Traders who engage in such hedging have a solid motivation to manage downside risk due to price fluctuations and active hedge re-balancing requirements because of the sensitive delta. This risk management requirement is reflected in fees charged by lenders. Our analysis provides insights into whether regulators and investors should be wary of increased bearish trading strategies in the derivatives market, which could inflate short-selling costs in the lending market. We further find that derivatives hedgers’ demand is sensitive to fees before negative earnings announcements, i.e., hedgers’ short-selling demand declines with higher loan fees. This effect reflects the fact that such hedgers short when they expect higher selling pressure, i.e., they sell low. In contrast, we find that the short-selling demand of traders who are not hedgers is positively associated with costs before the negative earnings information because they feel an urgency to generate profit with overvalued stocks; in other words, they sell high when in receipt of private bad news