The Rising Cost of Short Selling

A $300 Million Daily Inefficiency in U.S. Markets

By many measures financial markets have become more efficient. For example, the costs of acquiring information and the transaction costs associated with buying and selling US common stocks have fallen dramatically. And the percentage of active managers generating statistically significant alphas has fallen dramatically—from about 20% 30 years ago to about 2%. However, new research reveals that while most trading costs have plummeted over recent decades, the cost of borrowing stocks for short-selling has skyrocketed—creating market inefficiencies that exceed $300 million per day. The research exposes how structural problems in the securities lending market are undermining price discovery and costing investors billions.

Kent Daniel, Alexander Klos, and Simon Rottke, authors of the October 2025 study “Inefficiencies in the Securities Lending Market,” documented a striking paradox in modern finance—while technology and competition have dramatically reduced most trading costs over the past 25 years, one critical market function—securities lending for short-selling—has become far more expensive and, therefore, less efficient.

What the Researchers Examined

The authors conducted a comprehensive analysis of the U.S. securities lending market from 2003 to 2025, using data from:

• Markit’s securities lending database (tracking borrowing costs for stocks).

• CRSP stock returns (measuring performance).

• SEC N-PORT filings (revealing mutual fund lending behavior).

• 13F institutional holdings data (tracking investor positioning).

Their core questions: How have borrowing costs evolved, and what impact has this had on market efficiency and investor returns?

The Dramatic Rise in Borrowing Costs

Then vs. Now: A Shocking Comparison

In 2001, researcher Gene D’Avolio found that:

• Only 9% of stocks had borrowing fees above 1% annually.

• The highest fee observed was 79% per year.

• Fewer than 1% of stocks had “extreme” fees exceeding the risk-free rate.

By 2025, the picture had changed dramatically:

• 43% of stocks had fees above 1% by 2022.

• The highest fee recorded reached 1,000% annually (ARMP in May 2024).

• Over 100 stocks per day had fees exceeding 100% annually.

For the highest borrow cost security in their sample, the annualized fee was 1,000%, meaning the daily cost of borrowing approached 4%. By July 2022, 43% of stocks had borrow costs greater than 1%, up from just 10% at the start of their sample in June 2003.

Key Findings

1. A Near One-to-One Relationship Between Fees and Losses

The researchers formed portfolios based on borrowing costs and discovered that high-borrow-cost portfolios earned an annualized CAPM alpha of -81.4%. This means investors holding these stocks without lending them out lost approximately 81% of their value annually on a risk-adjusted basis—almost exactly matching the borrowing cost.

2. Short Sellers Break Even (But Can’t Profit)

Short sellers who incurred the massive costs fees to borrow shares (84.8%) lost 3.4% per annum. essentially broke even after costs. However, for “moderately expensive” stocks (10%-50% fees), short-sellers earned positive returns during the sample period.

3. Lenders Capture Only 60% of Fees

Lenders receive only about 60% of the fees that borrowers pay, with intermediaries (lending agents and prime brokers) capturing the remaining 40%. For even higher-cost stocks, intermediaries’ share was approximately 67%.

4. Institutional Investors Are Rationally Avoiding High-Fee Stocks

As borrowing costs have risen, funds holding these securities have learned they’re better off selling rather than lending them—even if they received the full borrowing cost, they would earn an alpha of zero or less. Given intermediation costs, they earn negative alphas by holding and lending these securities.

Using newly available N-PORT data, the researchers showed that even passive index funds now systematically underweight high-fee stocks—a remarkable deviation from their mandates.

5. A $300 Million Daily Inefficiency

The researchers calculated that since 2020, the inefficiencies associated with frictions in the securities lending market have exceeded $300 million per day. This represents a deadweight loss to the economy, as resources are allocated to rent-seeking activities in the intermediation chain rather than productive uses.

Why This Matters

The Vicious Cycle