Trader Leverage and Liquidity

71 Pages Posted: 19 Nov 2013 Last revised: 7 Jul 2016

Bige Kahraman

University of Oxford - Said Business School; Centre for Economic Policy Research (CEPR)

Heather Tookes

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

Date Written: July 6, 2016

Abstract

Does trader leverage drive equity market liquidity? We use the unique features of the margin trading system in India to identify a causal relationship between traders’ ability to borrow and a stock’s market liquidity. To quantify the impact of trader leverage, we employ a regression discontinuity design that exploits threshold rules that determine a stock’s margin trading eligibility. We find that liquidity is higher when stocks become eligible for margin trading and that this liquidity enhancement is driven by margin traders’ contrarian strategies. Consistent with downward liquidity spirals due to deleveraging, we also find that this effect reverses during crises.

Keywords: Trader Leverage, Market Liquidity, Funding Liquidity

JEL Classification: G10, G14

Suggested Citation

Kahraman, Bige and Tookes, Heather, Trader Leverage and Liquidity (July 6, 2016). Available at SSRN: https://ssrn.com/abstract=2356259 or http://dx.doi.org/10.2139/ssrn.2356259

Bige Kahraman (Contact Author)

University of Oxford - Said Business School ( email )

Park End Street
Oxford, OX1 1HP
Great Britain

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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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