Passive Ownership and Corporate Bond Lending

Abstract

Increased corporate bond ownership by passive funds reduces borrowing demand for these bonds, easing short-sale constraints in the corporate bond market. Passive ownership compresses credit spreads, lowering active investors’ buying pressure and consequently decreasing dealers’ need to borrow bonds for short-selling in market-making activities. When bonds cross maturity thresholds targeted by passive indices, temporary buying pressure from passive funds initially boosts bond borrowing. However, this trend reverses over the medium to long term as borrowing demand from insurers and active investors declines. These findings highlight a positive externality of passive bond ownership: it facilitates dealers’ capacity to manage customer-driven buying pressure. Given that bond borrowing primarily supports market-making and liquidity provision, our results caution against imposing short-sale restrictions on corporate bonds.

Presented by Yoshio Nozawa.