Leverage Constraints Affect Portfolio Choice: Evidence from Closed-End Funds

55 Pages Posted: 12 Jan 2021 Last revised: 23 Aug 2021

Date Written: August 23, 2021

Abstract

The market for auction rate securities collapsed in February 2008, significantly constraining some closed-end funds' access to leverage. We use this exogenous shock to study empirically how leverage constraints affect investors' portfolio choice. We find that tightened constraints result in an increased appetite for systematic risk: in the months following the shock, the affected funds bought significantly more high-beta stocks, and sold significantly more low-beta stocks, than their unaffected peers. Our results are consistent with the theoretical predictions of Black (1972) and Frazzini and Pedersen (2014) and provide causal evidence of the central mechanism underlying asset pricing under leverage constraints.

Keywords: leverage constraints, portfolio choice, closed-end funds

JEL Classification: G11, G12

Suggested Citation

Jylha, Petri and Rintamäki, Paul, Leverage Constraints Affect Portfolio Choice: Evidence from Closed-End Funds (August 23, 2021). Available at SSRN: https://ssrn.com/abstract=3722010 or http://dx.doi.org/10.2139/ssrn.3722010

Petri Jylha (Contact Author)

Aalto University ( email )

P.O. Box 21220
Aalto, 00076
Finland

Paul Rintamäki

Aalto University ( email )

P.O. Box 21210
Helsinki, 00101
Finland

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