Systematic Liquidity and Leverage
76 Pages Posted: 11 Nov 2016 Last revised: 1 Oct 2017
Date Written: September 30, 2017
Does trader leverage exacerbate the liquidity comovement that we observe during crises? Using a regression discontinuity design, we exploit threshold rules governing margin eligibility in India to analyze the impact of trader leverage on systematic liquidity. We find that trader leverage causes sharp increases in comovement during severe market downturns, explaining about one third of the increase in liquidity commonality during these periods. Consistent with downward price pressure due to deleveraging, we also find that trader leverage causes stocks to exhibit large increases in return comovement during these periods of market stress.
Keywords: Trader leverage, Systematic Liquidity
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