Shorting costs and profitability of long–short strategies

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.