Short selling with margin risk and recall risk

DOI10.1142/S0219024922500078MaRDI QIDQ5066301zbMATH OpenOpenAlexFDO

Authors Kristoffer J. Glover, Hardy Hulley

Publication date 29 March 2022

Published in International Journal of Theoretical and Applied Finance (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1903.11804

zbMATH Keywords

free-boundary problemlimits to arbitragemargin riskoptimal stoppingrecall riskshort selling

Mathematics Subject Classification ID

Stopping times; optimal stopping problems; gambling theory (60G40) Diffusion processes (60J60) Portfolio theory (91G10)

Abstract: Short sales are regarded as negative purchases in textbook asset pricing theory. In reality, however, the symmetry between purchases and short sales is broken by a variety of costs and risks peculiar to the latter. We formulate an optimal stopping model in which the decision to cover a short position is affected by two short sale-specific frictions---margin risk and recall risk. Margin risk refers to the fact that short sales are collateralised transactions, which means that short sellers may be forced to close out their positions involuntarily if they cannot fund margin calls. Recall risk refers to a peculiarity of the stock lending market, which permits lenders to recall borrowed stock at any time, once again triggering involuntary close-outs. We examine the effect of these frictions on the optimal close-out strategy and quantify the loss of value resulting from each. Our results show that realistic short selling constraints have a dramatic impact on the optimal behaviour of a short seller, and are responsible for a substantial loss of value relative to the first-best situation without them. This has implications for many familiar no-arbitrage identities, which are predicated on the assumption of unfettered short selling.

Recommendations

• Margins on short sales and equilibrium price indeterminacy
• Optimal timing for short covering of an illiquid security
• ARBITRAGE IN SECURITIES MARKETS WITH SHORT-SALES CONSTRAINTS
• Short sale constraints, correlation and market efficiency
• An empirical analysis of option pricing with short sell bans

Cites work

• A change-of-variable formula with local time on curves
• Capped stock loans
• scientific article; zbMATH DE number 5016447 (Why is no real title available?)
• scientific article; zbMATH DE number 1250597 (Why is no real title available?)
• scientific article; zbMATH DE number 3245741 (Why is no real title available?)
• Optimal redeeming strategy of stock loans under drift uncertainty
• Optimal selling of an asset under incomplete information
• Optimal timing for short covering of an illiquid security
• Properties of American option prices
• Stochastic methods for Dirichlet problems
• Stock loan with automatic termination clause, cap and margin
• Stock loans in incomplete markets
• Valuation of stock loans with jump risk

Cited in

(8)

• Optimal timing for short covering of an illiquid security
• Short selling and replaning as tools to enhance revenues
• Predatory short selling
• Short communication: clearing prices under margin calls and the short squeeze
• Perpetual American Standard and Lookback Options with Event Risk and Asymmetric Information
• Exploiting arbitrage requires short selling
• The Term Structure of Short Selling Costs
• Margins on short sales and equilibrium price indeterminacy

This page was built for publication: Short selling with margin risk and recall risk

Report a bug (only for logged in users!)Click here to report a bug for this page (MaRDI item Q5066301)