Abstract

http://ssrn.com/abstract=2356259
 
 

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Leverage Constraints and Liquidity: What Can We Learn from Margin Trading?


Bige Kahraman


Stockholm School of Economics - Department of Finance; Swedish House of Finance

Heather Tookes


Yale University - Yale School of Management; Yale University - International Center for Finance

July 1, 2014


Abstract:     
Do traders’ leverage constraints drive equity market liquidity? We use the unique features of the margin trading system in India to test the hypothesis that there is a causal relationship between traders’ leverage constraints (i.e., their ability to borrow to invest in risky assets) and a stock’s market liquidity. In India, the list of stocks eligible for margin trading is revised every month, creating a series of quasi-experiments that provide traders of newly eligible and ineligible stocks with shocks to the availability of leverage. We employ a regression discontinuity design that exploits the threshold rules that determine a stock’s margin trading eligibility. When we compare the liquidity of eligible and ineligible stocks that lie close to the eligibility threshold, we find that liquidity is higher when stocks become eligible for margin trading and that it decreases with ineligibility. Using available data on margin financing activity at the individual stock level, we try to uncover the mechanisms driving this main finding. We find evidence consistent with the idea that the liquidity enhancement that we observe stems from margin traders’ contrarian strategies.

Number of Pages in PDF File: 53

Keywords: Traders' Leverage, Market Liquidity, Funding Liquidity

JEL Classification: G10, G14

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Date posted: November 19, 2013 ; Last revised: July 21, 2014

Suggested Citation

Kahraman, Bige and Tookes, Heather, Leverage Constraints and Liquidity: What Can We Learn from Margin Trading? (July 1, 2014). Available at SSRN: http://ssrn.com/abstract=2356259 or http://dx.doi.org/10.2139/ssrn.2356259

Contact Information

Bige Kahraman (Contact Author)
Stockholm School of Economics - Department of Finance ( email )
SE-113 83 Stockholm
Sweden
Swedish House of Finance ( email )
Drottninggatan 98
111 60 Stockholm
Sweden

Heather Tookes
Yale University - Yale School of Management ( email )
135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States
Yale University - International Center for Finance ( email )
Box 208200
New Haven, CT 06520
United States
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