Margin Trading and Excess Comovement During Crises

71 Pages Posted: 11 Nov 2016 Last revised: 23 May 2019

See all articles by Bige Kahraman

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: May 20, 2019

Abstract

We exploit threshold rules governing margin trading eligibility in India to identify a causal link between margin trading and excess comovement during crises. Margin trading explains more than one quarter of the increase return comovement that we observe during crises. To understand the mechanisms driving this result, we evaluate the relative importance of stock connections through common brokers (who provide margin financing) versus common margin traders. We find that common brokers are most important. Margin-eligible stocks that are more connected through common brokers experience larger crisis-period increases in pairwise return comovement, especially when those brokers’ clients have experienced recent portfolio losses, when their clients have outstanding margin loans in more volatile stocks, and when the brokers are large. These findings are consistent with Brunnermeier and Petersen (2009), in which initial shocks propagate due to the tightening of margin constraints imposed by financial intermediaries.

Keywords: Margin Trading, Comovement, Crisis, Funding Constraints, Leverage, Regression Discontinuity Design

Suggested Citation

Kahraman, Bige and Tookes, Heather, Margin Trading and Excess Comovement During Crises (May 20, 2019). Saïd Business School WP 2016-27. Available at SSRN: https://ssrn.com/abstract=2868007 or http://dx.doi.org/10.2139/ssrn.2868007

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 )

London
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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