Disruptions in the Securities Lending Market: Evidence From the 2021 Short Squeeze

The smooth functioning of the stock lending market is essential for enabling short selling and maintaining effective arbitrage. Yet, little is known about how this low-transparency market responds to acute disruptions such as short squeezes. Short selling plays a central role in price efficiency, without which prices would disproportionately reflect the beliefs of the optimist. Cheap access to shares from lending institutions facilitates this process. The January 2021 short squeeze – centered around GameStop but involving a wider array of highly shorted equities – created extreme market conditions. While regulatory and academic attention has largely been focused on the squeeze’s effect on price volatility and more visible metrics of market quality, the squeeze’s effects on the stock lending market have not been thoroughly explored. Through an OLS regression framework, this paper analyzes how borrowing costs behaved across the highly shorted segment of the market, as compared to the non-shorted, broader market segment. The results show that during the squeeze, borrow fees increased, but only in the highly shorted group. In the post-squeeze period, borrow fees fell significantly, but again only within the highly shorted group. The stability of control group metrics supports the idea that the observed effects were concentrated solely within highly shorted equities. These results contribute to the literature on short sale constraints, bringing further implications for inefficiencies beyond what the existing literature had shown. Furthermore, this paper provides evidence that the lending market distortions brought on by a short squeeze may persist beyond the event window, interfering with effective arbitrage.