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Short Selling ETFs

We provide novel evidence that arbitrageurs use exchange-traded funds (ETFs) as an avenue to circumvent short-sale constraints at the stock level. Using a large sample of U.S. equity ETF holdings, we document that shorting activity on ETFs rises with the difficulty of shorting the underlying stocks. Stocks that are heavily shorted via their holding ETFs underperform those lightly shorted by 94 basis points per month. The return predictability of ETF short selling on individual stocks is distinct from stock-level shorting measures, and is concentrated among stocks that face the most severe arbitrage constraints. Across a broad set of capital market anomalies, we find that anomaly returns are significantly attenuated when ETF ownership is high. Our evidence suggests that ETFs contribute to a more informationally efficient market by allowing arbitrageurs to target overpriced stocks that are otherwise difficult to short.