Leverage Constraints, Arbitrage Capital, and Investor Under-reaction

70 Pages Posted: 26 Mar 2021

See all articles by Ferhat Akbas

Ferhat Akbas

University of Illinois at Chicago

Lezgin Ay

Iowa State University - Department of Finance, Ph.D. Student

Paul D. Koch

Iowa State University - Finance Department; Iowa State University - Finance Department

Date Written: February 24, 2021

Abstract

We analyze a hand-collected sample of earnings announcements over the period, 1934 – 1975, when the Fed changed margin requirements 22 times. We find that higher margin requirements are associated with greater under-reaction to earnings surprises. These results are stronger when investors face greater arbitrage risk or limited attention. They are robust when we control for macroeconomic conditions, financial market conditions, sentiment, or risk, and when we analyze several indirect measures of leverage constraints using more recent data. Our findings suggest that leverage constraints limit capital available to arbitrageurs, and thereby prevent the timely incorporation of earnings information into prices.

Keywords: Post-earnings announcement drift, PEAD, under-reaction, leverage constraints, margin requirements, limits to arbitrage

JEL Classification: G12, G14, G41

Suggested Citation

Akbas, Ferhat and Ay, Lezgin and Koch, Paul D., Leverage Constraints, Arbitrage Capital, and Investor Under-reaction (February 24, 2021). Available at SSRN: https://ssrn.com/abstract=3792433 or http://dx.doi.org/10.2139/ssrn.3792433

Ferhat Akbas

University of Illinois at Chicago ( email )

1200 W Harrison St
Chicago, IL 60076
United States

Lezgin Ay (Contact Author)

Iowa State University - Department of Finance, Ph.D. Student ( email )

Ames, IA 50011
United States

Paul D. Koch

Iowa State University - Finance Department

Ivy College of Business
Ames, IA 50011
United States
5152942491 (Phone)

HOME PAGE: http://https://www.business.iastate.edu/directory/pkoch/

Iowa State University - Finance Department

Ames, IA 50011-2063
United States
5152942491 (Phone)

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