Trader Leverage and Liquidity

Kahraman, Bige; Tookes, Heather

doi:10.1111/jofi.12507

Cited by 78 publications

(36 citation statements)

References 79 publications

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“…Margin financing is a high-risk double-edged sword. Although some propose that stock price behaviour indicates [5,6,7] that margin eligibility can raise liquidity [8] and stabilize the market [9], others argue that margin trading produces excess volatility and destabilizes the market [10,11]. We conjecture that margin trading activities are a strong factor in the drop in stock prices during a crash and can accelerate the decline.…”

Section: Introductionmentioning

confidence: 88%

The impact of margin trading on share price evolution: A cascading failure model investigation

Gao

Tang

Cai

et al. 2018

Physica A: Statistical Mechanics and its Applications

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Margin trading in which investors purchase shares with money borrowed from brokers is blamed to be a major cause of the 2015 Chinese stock market crash. We propose a cascading failure model and examine how an increase in margin trading increases share price vulnerability. The model is based on a bipartite graph of investors and shares that includes four margin trading factors, (i) initial margin k, (ii) minimum maintenance r, (iii) volatility v, and (iv) diversity s. We use our model to simulate margin trading and observe how the share prices are affected by these four factors. The experimental results indicate that a stock market can be either vulnerable or stable. A stock market is vulnerable when an external shock can cause a cascading failure of its share prices. It is stable when its share prices are resilient to external shocks. Furthermore, we investigate how the cascading failure of share price is affected by these four factors, and find that by increasing v and r or decreasing k we increase the probability that the stock market will experience a phase transition from stable to vulnerable. It is also found that increasing s decreases resilience and increases systematic risk. These findings could be useful to regulators supervising margin trading activities.

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Section: Introductionmentioning

confidence: 88%

The impact of margin trading on share price evolution: A cascading failure model investigation

Gao

Tang

Cai

et al. 2018

Physica A: Statistical Mechanics and its Applications

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“…Hedegaard (2014) finds that following a margin increase, the price impact of trading increases for both the affected contract and for the remaining contracts in the market, documenting funding illiquidity spillovers. Kahramand and Tookes (2016) employ a regression discontinuity design based on the threshold rules that determine a stock's margin trading eligibility in India to identify a causal relationship between traders' ability to borrow and a stock's market illiquidity. They find that illiquidity is lower when stocks become eligible for margin trading.…”

Section: Related Literaturementioning

confidence: 99%

Funding Constraints and Market Illiquidity in the European Treasury Bond Market

Research¹

2018

SSRN Journal

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Theoretical studies show that shocks to funding constraints should affect and be affected by market illiquidity. However, little is known about the empirical magnitude of such responses because of the intrinsic endogeneity of illiquidity shocks. This paper adopts an identification technique based on the heteroskedasticity of illiquidity proxies to infer the reaction of one measure to shocks affecting the other. Using data for the European Treasury bond market, we find evidence that funding illiquidity shocks affect bond market illiquidity and of a weaker simultaneous feedback reverse. We also investigate the determinants of the magnitude of these effects in the cross-section of bonds and find that the responses of individual bonds' market illiquidity to funding illiquidity shocks increase with bond duration, with the credit risk of the issuer, and with haircuts.

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“…They find that informed traders and voluntary market-makers revise orders more often, and that changes in market prices and inventories, including inventories of other related stocks, influence order revisions. Kahraman and Tookes (2017) find that the ability to trade on margin increases liquidity; however, in crisis periods, due to massive deleveraging liquidity deteriorates (i.e., there is a downward liquidity spiral).…”

Section: Related Literaturementioning

confidence: 99%