Mike Lipkin
Columbia University/
Katama Trading LLC
Restrictions on the shorting of stocks have the paradoxical effect of increasing volatilities and prices. We demonstrate this with a simple but very rich stochastic model which reproduces market prices and allows predictions about asset bubbles as well!
We study the price-evolution of stocks that are subject to restrictions on short-selling, generically referred to as hard-to-borrow. Such stocks are either subject to regulatory short-selling restrictions or have insufficient float available for lending. Traders with short positions risk being bought-in, in the sense that their positions may be closed out by the clearing firm at market prices. The model we present consists of a coupled system of stochastic differential equations describing the stock price and the buy-in rate, an additional factor absent in standard models. The conclusion of the model is that short-sale restrictions result in increased prices and volatilities. Our model prices options as if the stock paid a continuous dividend, reflecting a modified form of Put-Call parity. Another consequence is that stocks that do not pay a dividend may have calls subject to early exercise. Both features are in agreement with empirical observations on hard-to-borrow stocks.
Friday, April 2, 2010 at 4:00 PM
Room L211, Technological Institute
Refreshments are served at 3:30 PM
