Abstract

We find that Exchange-Traded Funds (ETFs) are more expensive to borrow than stocks, and we provide an explanation for this difference. This phenomenon is due to features specific to the ETF lending market rather than due to the stocks the ETFs hold, as ETF loan fees tend to be higher than the average of their constituent stocks. We find that for most indices, one ETF tends to capture the majority of the short interest. This “short favorite” ETF tends to have low loan fees, while the “non-favorite” ETFs tend to be much more expensive to short and are less liquid. Demonstrating the magnitude of ETF loan fee differences within each index, we examine the returns to a within-index, cross-ETF arbitrage strategy which is profitable due to persistent loan fee differences across ETFs tracking the same index. Cross-ETF arbitrage returns are quite high and stable. Even when we partially constrain an investor’s ability to fully lend out their long position, we still find that the cross-ETF arbitrage strategy is profitable for about 2/3 of the indices in our sample. The results shed light on limits to arbitrage in the market for exchange-traded funds and provide an explanation for the high ETF loan fees that we observe.

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• Keyword(s):
• finance 249

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