Leverage is a Double-Edged Sword
83 Pages Posted: 28 May 2021 Last revised: 8 Dec 2021
Date Written: May 28, 2021
We use proprietary data on intraday transactions at a futures brokerage to analyze the mechanisms by which implied leverage influences trading performance, conditional on investor skill. We measure skill during a training period, and analyze performance out of sample. Leverage stimulates de facto liquidity provision by skilled investors, and enhances their daily returns by 19.3 bps per unit. Unskilled investors’ leverage amplifies their losses, particularly those stemming from gambling proclivity. Across all individuals and institutions, forced liquidations largely account for the negative impact of leverage on performance. Regulatory increases in required margins decrease (enhance) skilled (unskilled) investors’ performance.
Keywords: Leverage, Futures, Margin call, Smart investors, Trading performance
JEL Classification: D03, D81, G02, G12, G23
Suggested Citation: Suggested Citation