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The borrower of the asset is incentivised by the belief that the relative value of the asset will go down (he can then sell it at high price now and buy back cheaper later).

But what incentivises the lender? It can't be the belief that the relative value of the asset will go up (since then he could just hold onto the asset). So it must be some sort of a premium (like an extra quantity of asset returned / interest) that motivates the lender; is that correct?

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closed as off-topic by noob2, LocalVolatility, Helin, Bob Jansen Jan 26 '18 at 9:42

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  • $\begingroup$ It's called repo or short-stock rate. The borrower pays it to the lender. Otherwise there would be no incentive - as you said. $\endgroup$ – LocalVolatility Jan 19 '18 at 13:26
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Yes, it is the borrow rate that the short seller pays to borrow the stock from the long holder. The rate increases as the stock goes "special"--meaning that there is a large demand too borrow stock from short sellers.

There are a number of investors, such as index funds and pension funds that require them to hold all the stock in an index. Therefore they do not make any market calls on individual stocks. As such, the performance on their portfolio is compared to the performance of the index they are trying to track. They increase their returns relative to the index by lending the shares they are required to hold to the short sellers.

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  • $\begingroup$ Nice example with the index funds being lenders -- makes sense. Curious -- does the borrow rate on say stocks work like: a rate of 2% means returning 102 stocks after year (analogous to monetary asset, say USD)? Reading on Repos it seems more murky -- an exchange of both base asset (stock) and relative asset (say USD) takes place. $\endgroup$ – A.L. Verminburger Jan 19 '18 at 14:26
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    $\begingroup$ The payment is in the form of cash, not additional shares. Also, these loans are usually not to term. The stocks are usually loaned on a day to day basis; the stock lender can recall the loan at any time so they can sell the shares if they choose not to hold it any longer. But as long term investors hold stocks for long time periods, it is usually out for an extended period of time. The interest and borrow fee, less any rebate is paid for the time the stock is borrowed. $\endgroup$ – AlRacoon Jan 19 '18 at 14:39
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    $\begingroup$ "...lender can recall the loan at any time ... " -- does not sound too good for the borrower. $\endgroup$ – A.L. Verminburger Jan 19 '18 at 14:41
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    $\begingroup$ Usually the stock loan is facilitated through a custodian or a prime broker. As the custodian holds the shares for a large number of investors, if a particular lender recalls the stock to sell it, the custodian can replace the loan with another investors holdings in that same stock. The stock loan is from a pool of holders that are willing to lend the stock. Of course there is a fee split between the custodian and the holder of the shares in this case. Large funds may have their own lending desk. $\endgroup$ – AlRacoon Jan 19 '18 at 14:51

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