Shorting costs and profitability of long–short strategies

Dongcheol Kim and Byeung‐Joo Lee

Accounting and Finance, 2023, vol. 63, issue 1, 277-316

Abstract: We examine how the profitability of long–short arbitrage strategies based on anomalies is affected after adjustment for two shorting costs: implicit cost due to unavailability of stocks in the short‐leg to sell short and loan fees actually paid to stock lenders. The combined shorting cost amounts to almost 40 percent of long–short gross returns over the sample period from January 2006 to December 2017. After adjustment for these shorting costs, long–short arbitrage profits are thus reduced by almost 40 percent. Even after adjustment for risk, the proportion of shorting costs is also substantial. If other trade‐related transaction costs are considered, long–short arbitrage profits would be reduced further. Our results provide explicit evidence that casts doubt on the profitability of long‐short arbitrage strategies based on anomalies.

Date: 2023
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