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Margin Trading, Overpricing, and Synchronization RiskSanjeev BhojrajCornell University - Samuel Curtis Johnson Graduate School of Management Robert J. BloomfieldCornell University - Samuel Curtis Johnson Graduate School of Management William B. TaylerBrigham Young University Review of Financial Studies, Forthcoming Abstract: We provide experimental evidence that relaxing margin restrictions to allow more short-selling can exacerbate overpricing, even though it reduces equilibrium price levels. This is because smart-money traders initially profit more by front-running optimistic investor sentiment than by disciplining prices. When short-selling is not possible, competitive pressures among arbitrageurs rapidly drive them to the equilibrium. However, the risk of margin calls slows the convergence process, because arbitrageurs who sell short too early face substantial losses if they are unable to synchronize their trades with other arbitrageurs (as in Abreu and Brunnermeier 2002; 2003).
Number of Pages in PDF File: 54 Keywords: Market Efficiency, Limits to Arbitrage, Bubbles, Experimental Economics JEL Classification: A10, C90, C72, G10, M40, G30, G14, C92 working papers seriesDate posted: August 24, 2005Suggested CitationContact Information
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