71 Pages Posted: 19 Nov 2013 Last revised: 7 Jul 2016
Date Written: July 6, 2016
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: Suggested Citation