Deleveraging Commonality

Abstract

This paper empirically shows that stock-level margin trading commoves significantly with market-aggregate margin trading even after controlling for market return, market-wide liquidity, and individual determinants of margin trading. A closer examination suggests that the common influences and positive feedback mechanisms exhibit considerable variations depending heavily on market conditions, firm characteristics, and the direction of margin change. Specifically, the commonality during the deleveraging process is more pronounced than when leverage increases, and such deleveraging commonality contributes to the worsening of stock liquidity and heightened surges in liquidity commonality. Relying on empirical measures constructed through the limit order book, we further find that market-aggregate margin trading generates much larger impacts on selling pressures and investors’ order submission strategies than its stock-level counterpart during market crashes. Overall, recognizing the existence of commonality offers a simple and alternative way to think about the systematic risk arising from leverage trading.

Keywords: deleveraging commonality, leverage, liquidity, market resiliency

JEL Classification: G1