Margin regulation and volatility

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may AbstractIn this paper we examine the quantitative effects of margin regulation on volatility in asset markets. We consider a general equilibrium infinite-horizon economy with heterogeneous agents and collateral constraints. There are two assets in the economy which can be used as collateral for short-term loans. For the first asset the margin requirement is exogenously regulated while the margin requirement for the second asset is determined endogenously. In our calibrated economy, the presence of collateral constraints leads to strong excess volatility. Thus, a regulation of margin requirements may have stabilizing effects. However, in line with the empirical evidence on margin regulation in U.S. stock markets, we show that changes in the regulation of one class of assets may have only small effects on these assets' return volatility if investors have access to another (unregulated) class of collateralizable assets to take up leverage. In contrast, a countercyclical margin regulation of all asset classes in the economy has a very strong dampening effect on asset return volatility.Keywords: collateral constraints, general equilibrium, heterogeneous agents, margin requirements, Regulation T.JEL Classification Codes: D53, G01, G12, G18.ECB Working Paper 1698, July 2014 1 Non-Technical SummaryRegulating margin requirements or haircuts for securities financing transactions has for a long time been considered as a potential tool to limit the build-up of leverage and dampen volatility in financial markets. For example, following the US stock market crash in 1929 the Federal Reserve Board (FRB) was granted the power to set initial margin requirements for margin trading, i.e. investors building a leveraged position in securities using loans that are collateralised by the securities that are purchased. The margin requirement dictates how much investors can borrow against these securities. The FRB established Regulation T to set minimum margin requirements for such partially loan-financed transactions of exchange-traded securities. However, the majority of empirical studies analysing Regulation T did not provide substantial evidence that regulating margin requirements in stock markets had an economically significant impact on market volatility. Eighty years later, in the aftermath of the financial crisis of 2007-2009, it has again been argued that excessively low margin requirements or haircuts contributed both to the buildu...

On Collateral: Implications for Financial Stability and Monetary Policy

“…To prevent excessive margining and eliminate self-fulfilling panics, ex-ante minimum margin/liquidity requirements and/or ex-post margin caps may be needed (Biais, Heider and Hoerova, 2015). For minimum margin requirements and countercyclical variation of margins to be effective, a broad application across products is important, to reduce leakage into products not subject to the regulation (Brumm, Grill, Kubler and Schmedders, 2015). Lastly, central bank asset purchase programs may allow borrowers to reduce illiquid leverage and their exposure to risky securities and thereby increase welfare (Ranaldo, Rupprecht and Wrampelmeyer, 2016).…”

Collateral constraints and asset prices

“…Our paper is related to the literature on the economic effects of borrowing, margin, short-sale, and position limit constraints (e.g., Harrison and Kreps, 1978;Detemple and Murthy, 1997;Basak and Cuoco, 1998;Croitoru, 2000, 2006;Pavlova and Rigobon, 2008;Gârleanu and Pedersen, 2011;Chabakauri, 2013Chabakauri, , 2015Rytchkov, 2014;Brumm et al, 2015;Buss et al, 2016), portfolio insurance (e.g., Basak, 1995) and VaR constraints (e.g., Basak and Shapiro, 2001). Our economic results are different from the results in this literature.…”

Inequality and Asset Fire Sales

“…Therefore, they incur more severe disutility from trading securities, which requires large amounts of time. 8 Second, we make an assumption of idiosyncratic endowments. The assumption states that idiosyncratic income risk is countercyclical because state b represents a recession in our setting.…”