Leverage is a Double-Edged Sword

Journal of Finance, forthcoming

88 Pages Posted: 28 May 2021 Last revised: 24 Jun 2023

See all articles by Avanidhar Subrahmanyam

Avanidhar Subrahmanyam

University of California, Los Angeles (UCLA) - Finance Area; Financial Research Network (FIRN)

Ke Tang

Institute of Economics, School of Social Sciences, Tsinghua University

Jingyuan Wang

Beihang University (BUAA)

Xuewei Yang

Nanjing University - School of Management and Engineering; Nanjing University - Institute of New Finance

Date Written: May 28, 2021

Abstract

We use proprietary data on intraday transactions at a futures brokerage to analyze how implied leverage influences trading performance. Across all investors, leverage is negatively related to performance, due partly to increased trading costs and partly to forced liquidations resulting from margin calls. Defining skill out of sample, we find that relative performance differentials across the unskilled and skilled persist. Unskilled investors' leverage amplifies losses from lottery preferences and the disposition effect. Leverage stimulates liquidity provision by the skilled, and enhances returns. Although regulatory increases in required margins decrease skilled investors' returns, they enhance overall returns, and attenuate return volatility.

Keywords: Leverage, Futures, Margin call, Smart investors, Trading performance

JEL Classification: D03, D81, G02, G12, G23

Suggested Citation

Subrahmanyam, Avanidhar and Tang, Ke and Wang, Jingyuan and Yang, Xuewei, Leverage is a Double-Edged Sword (May 28, 2021). Journal of Finance, forthcoming, Available at SSRN: https://ssrn.com/abstract=3855181 or http://dx.doi.org/10.2139/ssrn.3855181

Avanidhar Subrahmanyam

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-5355 (Phone)
310-206-5455 (Fax)

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

Ke Tang

Institute of Economics, School of Social Sciences, Tsinghua University ( email )

No.1 Tsinghua Garden
Beijing, 100084
China

Jingyuan Wang

Beihang University (BUAA) ( email )

37 Xue Yuan Road
Beijing 100083
China

Xuewei Yang (Contact Author)

Nanjing University - School of Management and Engineering ( email )

22 Hankou Road, Gulou District
Nanjing, Jiangsu 210093
China

Nanjing University - Institute of New Finance ( email )

Nanjing, Jiangsu 210093
China

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