Leveraged Speculators and Asset Prices
52 Pages Posted: 18 Nov 2014 Last revised: 6 Dec 2019
Date Written: April 16, 2018
I test the hypothesis that the use of leverage by market speculators can amplify economic shocks in stock markets. Using a direct leverage measure derived from U.S. public filings, I find that upon extremely negative earnings surprises, stocks held by highly leveraged hedge funds exhibit abnormal price declines and subsequent reversal. Consistent with the fire-sale hypothesis, high-leverage funds tend to reduce the position following negative news about a stock, compared to less leveraged funds. I further provide evidence of contagion: such fire sales can extend to other stocks in the portfolio, thereby increasing the crash-proneness of these stocks.
Keywords: Crashes, hedge fund leverage, skewness, fire sales
JEL Classification: G12; G23
Suggested Citation: Suggested Citation