Margin Requirements and the Security Market Line
52 Pages Posted: 19 Nov 2013 Last revised: 21 Jun 2017
Date Written: June 12, 2017
Between the years 1934 and 1974, the Federal Reserve changed the initial margin requirement for the U.S. stock market 22 times. I use this variation to show that investors leverage constraints affect the pricing of risk. Consistent with the theoretical predictions of Frazzini and Pedersen (2014), I find that tighter leverage constraints result in a flatter relation between betas and expected returns. My results provide strong empirical support for the idea that constraints faced by investors may, at least partially, help explain the empirical failure of the capital asset pricing model.
Keywords: Leverage constraints, security market line, margin regulation
JEL Classification: G12, G14, N22
Suggested Citation: Suggested Citation