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The Market for Borrowing Corporate Bonds

This paper examines three primary hypotheses about the market for borrowing corporate bonds. The first is whether borrowing corporate bonds is more expensive and illiquid than borrowing stock. It is not. The borrowing costs for corporate bonds are usually low and linked to the costs of borrowing stock. In addition, we estimate that shorting represents 19.1% of corporate bond trades. The second hypothesis is whether bond shorting is motivated by investors possessing private information.

The evidence is that it is not and bond short sellers do not on average earn excess returns. The third primary hypothesis we examine is whether bond borrowing activity is affected by the credit default swap (CDS) market. While it appears that bond shorting and CDS issuance are correlated, bond short selling has not been replaced by the growth of CDS.

Short selling, where feasible, is an important activity in many asset markets. Constraints on short selling may lead to mis-valuation because they limit the ability of some market participants to influence prices. These constraints include various institutional or legal prohibitions on taking short positions as well as the additional costs and risks associated with short selling. There is a large theoretical literature on short sales constraints and their impact on asset prices. The empirical literature on short sales, while also large, has focused almost exclusively on stocks.

In this paper, we analyze the market for borrowing and shorting corporate bonds. The corporate bond market is one of the largest over-the-counter (OTC) financial markets in the world. Between 2004 and 2007, the time period of our study, the value of outstanding corporate debt averaged slightly over $6 trillion dollars and, according to the Securities Industry and Financial Market Association (SIFMA), trading activity averaged $17.3 billion per day.

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The Market for Borrowing Corporate Bonds