Mispricing and Anomalies: An Exogenous Shock to Short Selling from JGTRRA

We study the causal effect of short selling on asset pricing anomalies by exploiting a novel exogenous shock to short selling. After the Job and Growth Tax Relief Reconciliation Act (JGTRRA) of 2003, equity lenders are reluctant to lend shares around the dividend record dates because substitute dividends that they would receive are taxed at ordinary income rates while qualified dividends are taxed at 15 percent, thus creating a negative shock to short selling. Using arguably the most comprehensive set of anomalies to date and the difference-in-differences (DID) regression framework, we find that anomalies become stronger after the dividend record months in the post-JGTRRA periods, driven by stronger mispricing in the dividend record months. We further show that the effect mainly comes from the overpriced stocks. Overall, our results provide strong evidence that most anomalies are likely due to mispricing, with valuation anomalies as an exception.