On the Effectiveness of the Federal Reserve's Margin Requirement

Abstract

A portfolio-theoretic model of the optimal margin account is developed. It is argued that the Federal Reserve's goal in setting the margin requirement is to influence investor equity ratios. Using the average equity ratio as the dependent variable and the arguments of the model as independent variables, an empirical model is estimated. It is concluded that the margin requirement is an effective regulatory tool. THE STATE OF THE art with respect to the question of the effectiveness of theFederal Reserve's initial margin requirement is anomalous. Notwithstanding the profession's current obsession with the tools of monetary policy, there are only two extant studies dealing with the central issue-the effect of changes in Regulation T on margin credit extended by securities dealers.1 Moreover, the two studies that do exist reach opposite conclusions-one that the margin requirement is effective, the other that it is not.Both studies are quite dated. The first, that of Bogen and Krooss [1], examined the behavior of various stock market series in the six months before and after a change in the margin requirement. One of their findings was that increases in customer net debit balances always either slowed or reversed when the margin requirement was raised, and conversely for decreases in the margin requirement. On the basis of this evidence, Bogen and Krooss concluded that changes in the margin requirement "have to date [1960] achieved the primary objective of limiting and regulating the volume of security credit" [1, p. 157]. However, Bogen and Krooss also found that the quantitative behavior of customer net debit balances seemed to bear no relation to the size of the change in the margin requirement.The only other study dealing with this issue is that done by Moore [7], published in 1966. Of the various empirical tests Moore conducted, one is of the Federal Reserve Bank of Kansas City; the editor of this journal; and Dwight M. Jaffee, for many helpful comments. William Colclough, graduate assistant, did the computations.'The two studies discussed in the text are the only studies dealing with the effects of margin requirement changes on stock-market credit. Three other studies are, however, worthy of brief note. Grube, Joy, and Panton [4], in a test of the efficient market hypothesis, examine stock price and trading volume movements in the 25 days before and after margin requirement changes. While their results are mixed, they generally conclude that the announcement effects of such changes are minimal. Largay [6], and Eckardt and Rogoff [2] examined the effect on price and trading volume of the imposition of special 100% margins on particular stocks by the stock exchanges. Both studies conclude that the imposition of such special margins is effective in the period immediately following the change. 784The Journal of Finance

Price volatility, international market links, and their implications for regulatory policies

“…Largay does report that price volatility decreased after the imposition of 100 percent margins, but the empirical results are not givenY The direct effectiveness of the Fed's margin requirements on reducing borrowing (in broker margin accounts) was presented by Luckett (1982). Luckett does find evidence that increased margin requirements reduced borrowing in the 1966--1979 period; his empirical estimates indicate "... that a 10 percent change in the Federal Reserve's margin requirement will change investor equities on stocks held in margin accounts at security dealers by about 1 1/2 to 2 percent" (p. 794).…”

Policy on the margin: Evaluating the impact of margin debt requirements on stock valuations

“…Aside from margin requirements, households' decisions to borrow more on margin are also expected to be positively related to the past real stock market index (here the S&P 500) 3 , and negatively related to risk and to the consumer credit burden. Following earlier work, risk is measured as the difference between the yields on Moody's Baa-and Aaa-rated bonds (Luckett 1982). Finally, the effects of real income and households wealth are ambiguous.…”

“…Grube et al (1979) found that lower margin requirements are linked to higher aggregate prices, but that there was no correlation between higher margin requirements and prices. Further, Luckett (1982) examined the impact of margin requirements on equity holdings and found that margin requirements are an effective regulatory tool as higher margin requirements reduce equity holdings.…”

Margining option portfolios by network flows

“…We can point to only two books [Geelan and Rittereiser, 1998;Curley, 2008], three papers [Rudd and Schroeder, 1982;Fiterman and Timkovsky, 2001;Coffman et al, 2010b] devoted to margining algorithms and two papers [Fortune, 2000[Fortune, , 2003 devoted to margining practice. Literature on studying the influence of margin requirements on the market, such as for example [Moore, 1966;Luckett, 1982], is more representative; see the related survey in [Kupiec, 1998]. The vast majority of publications on margining consists primarily of regulatory circulares and manuals written by security market lawyers.…”