Should Retail Investors' Leverage Be Limited?

63 Pages Posted: 23 Sep 2012 Last revised: 2 Apr 2018

See all articles by Rawley Heimer

Rawley Heimer

Boston College - Department of Finance

Alp Simsek

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: December 25, 2017

Abstract

Does the provision of leverage to retail traders improve market quality or facilitate socially inefficient speculation that enriches financial intermediaries? This paper evaluates the effects of 2010 regulations that cap the provision of leverage to previously unregulated U.S. retail traders of foreign exchange. Using three unique data sets and a difference-in-differences approach, we document that the leverage constraint reduces trading volume by 23 percent, improves high-leverage traders' portfolio return by 18 percentage points per month (thereby alleviating their losses by 40 percent), and reduces brokerages' operating capital by 25 percent. Yet, the policy does not affect the relative bid-ask prices charged by the brokerages. The announcement of pending leverage restrictions has no effect on the traders or the market. We reconcile these findings with a model in which traders with heterogeneous and dogmatic beliefs take speculative positions in pursuit of high returns, and a competitive brokerage sector intermediates these trades subject to technological and informational costs. The model is largely consistent with our empirical findings, and it suggests that the leverage constraint policy generates a sizable belief-neutral improvement in social welfare by economizing on the productive resources used to intermediate speculation.

Keywords: Leverage Constraints, Retail Trading, Speculation, Brokerage Sector, Bid-Ask Spreads, Welfare Criterion

JEL Classification: F31, G18, G11, G00

Suggested Citation

Heimer, Rawley and Simsek, Alp, Should Retail Investors' Leverage Be Limited? (December 25, 2017). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=2150980 or http://dx.doi.org/10.2139/ssrn.2150980

Rawley Heimer (Contact Author)

Boston College - Department of Finance ( email )

Carroll School of Management
140 Commonwealth Avenue
Chestnut Hill, MA 02467-3808
United States

Alp Simsek

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

50 Memorial Drive E52-552
The Morris and Sophie Chang Building
Cambridge, MA 02142
United States
617-2585630 (Phone)

HOME PAGE: http://https://economics.mit.edu/faculty/asimsek

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

HOME PAGE: http://https://economics.mit.edu/faculty/asimsek

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Register to save articles to
your library

Register

Paper statistics

Downloads
429
Abstract Views
2,366
rank
65,899
PlumX Metrics