SHORT SELLING WITH MARGIN RISK AND RECALL RISK

To investigate the effect of short-selling constraints on investor behavior, we formulate an optimal stopping model in which decision to cover a short position is affected by two sale-specific frictions — margin risk and recall risk. Margin introduced assuming that seller forced close out their involuntarily if they cannot fund calls (since sales are collateralized transactions). Recall permitting lender borrowed stock at any time, once again triggering involuntary close-out. Examining these close-out strategy associated value function, finding behavior can be qualitatively different presence. Moreover, lead substantial loss value, relative first-best situation without them (a reduction approximately 17% for our conservative base-case parameters). This significant has important implications many familiar no-arbitrage identities, predicated assumption unfettered selling.